JavBlog: Javelin Wealth Management Investment Commentary

Two out of three ain't bad

2012-02-08T19:07:00.000-08:00

Back in October we wrote that we were looking for three things to happen to encourage us to get more positive on stock markets: signs of stronger US employment, some prospect of an end to monetary tightening in China and some real progress (if not final resolution) to the European debacle.

As Meatloaf memorably sang in 'Bat Out Of Hell', two out of three ain't bad, even if the third (Europe) still has plenty of potential to throw a large spanner through a more cautiously optimistic picture.

The US numbers are improving across a range of different data: employment is up, credit delinquencies are down, manufacturing export orders have picked up, labour costs are down (implying corporate margins and productivity are up), housing affordability has increased (because housing prices have collapsed). All pretty decent sounding news. Combine that with confirmation from the Fed that low interest rates are going to be with us for a while, and you have the makings of a good story.

In China, too, the focus on beating inflation seems to be easing off, with the result that fears of a hard landing seem to have receded somewhat.

All of this is cheery stuff, particularly when compared with the worries that dogged markets in mid 2011.

And that brings us on to Europe.

The surprise in the last few months is how quickly markets have been to assume that a deal will be done over Greece that will push the European crisis on to the backburner for a while. The moves by the ECB to ease credit to banks from mid December was an undoubted and major factor behind this and seemed to suggest that banks would be underpinned unconditionally. Even the Germans seem to have given up grumbling (in public).

Nevertheless the skeptics remain unconvinced, simply because the debt numbers are so large whilst the impetus for major structural change - not just in Greece, but the US, France and elsewhere - seems to have stalled. Without this major structural change (which involves acknowledging that previous commitments on pensions and health care provision are unaffordable), debt levels will continue to grow until they reach the point at which bond investors vote with their feet and force change by their actions. So far, of course, bond markets outside of the obvious basket cases in Europe have chosen to ignore all of this.

Where do we stand in this?

We've ceratainly been adding some equity exposure for some clients over the last month or so, but still have cash in reserve: too frequently have we seen declarations from Europe that a line has been drawn under the crisis. We therefore skeptically feel the need to see the detail before being convinced. So at present, we regard the current market jumps as being more driven by short-term trading impulses than longer-term investors. It may well be that when the latter get involved, the nimble money may be making it's way out again, happy in its quick profits. The question then will be whether or not the longer term money has enough room to benefit.

However, with a 66% positive signal on our "Meatloaf Index" and with deposit rates in the cellar, this trading rally could continue for a little while, particularly if the Europeans find a large band aid for Greece to see them through for another few months. They still can't afford it, but at the moment markets are behaving as though it's better to keep eyes tight shut.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

The Germans have a cunning plan...

2012-01-13T01:39:00.001-08:00

One of my previous postings encouraged one of our friends, a long-term resident in Germany, to get in touch: he felt that we would benefit from the Berlin perspective. His thoughts are interesting, so I have, with his permission, paraphrased them here...

The Germans are playing a complex political end game in order to ensure that they are able to push through a restructuring of Europe’s economic machinery, based on German principles. They feel that they made a compromise when the foundations of the Euro were laid during the 1990’s in the interests of political expediency (common interest rate setting, despite the lack of common fiscal or debt mechanisms – the Bundesbank definitely “knew better”).

They clearly hoped – wrongly as it has turned out – that the Euro would run for longer without meeting with a structural crisis. Now that it has happened, they don’t want to make this type of compromise again in which expediency, rather than logic, drives policy.

The political manoeuvring which seems endemic within the current structure of the EU is very complex and often seems both chaotic and smacking of incompetence and indecision.

However, the German elite has a very clear idea where it wants Europe to go: towards fiscal union for an appropriate set of countries (my italics).

Having now successfully absorbed a defunct country – East Germany – with 25 million people, produced a DAX which is well represented by world leading companies, and developed a unique breadth of mid-sized, export orientated companies in many industries (the famous Mittelstand), DAX listed companies are some of the most globalised in the world, and look both to Asia and the US for their continued growth.

All this manufacturing success has engendered a new sense of self-confidence in Berlin, leading to the explicit belief that they actually do know something about business and economics, and don't need any lessons from the Brits or the Americans.

It is clear, however, that German leaders do not feel comfortable with overt displays of such confidence, given sensitivities to the "Don’t mention the war…" creed. Basil Fawlty would be proud.

Despite this, there is a clear view that the German business model, as opposed to the debt fuelled Anglo-Saxon one, needs no further apology. But nor does that mean that Germany should act as the banker for everyone else in Europe.

When Cameron visited Berlin in mid-November, he told his German counterpart that as much firepower as possible had to be used to combat the euro crisis. To which the Chancellor responded coolly: "One shouldn't pretend to have power that one doesn't actually have”.

From the German perspective, the only way to remain relevant in a world economy dominated by the USA & China is for Europe to make a rapid dash for size via full fiscal union.

Chancellor Merkel is a quantum chemist by training and spent the first 12 years of her professional life in a Physical Chemistry institute in the DDR. She might not be as strong on media and communication skills as many of her contemporaries, but it’s doubtful that many of them can match her in the analysis of complex problems.

Her preferred approach to politics can be compared to experimental particle physics. She engineers collisions between other particles and sees what happens. After the experiment, she moves in to fill the vacuum.

Poor particles.

Thus all of her contemporary competitors for leadership in the CDU/CSU were masterfully able to discredit themselves in the maelstrom of personal rivalries and their subsequent disputes. These direct competitors for leadership ten years ago have long since left politics for business, leaving the field clear for Frau Merkel.

And now she is applying the same tactics in the EU.

Let Berlusconi discredit himself. Let Sarkozy hog the limelight in public disputes with Cameron. Frau Merkel will watch from the sidelines whilst engineering the desired end result. Very Machiavellian (if one is allowed to reference the work of a 16th century Italian).

So – you have a major player in the EU crisis playing a long-term strategy, whilst everyone else is focused on short-term tactics: hence the friction, and hence the appearance of indecision in the face of huge challenges. The Germans are playing the long game.

Note also that German politicians don't care what the stock market does - due to limited share ownership, it is electorally irrelevant. This provides us with an interesting contrast to the US: Ben Bernanke has frequently emphasized that he uses the stockmarket as a key indicator for the success or otherwise of his Quantitive Easing and other policies.

With many thanks to our friend in Berlin.

It remains to be seen whether or not the German Chancellor's long game will pay off, or, in the words of another British prime minister, be sidetracked by the challenges posed by "events".

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Backwards and forwards for 2011 and 2012

2011-12-21T22:07:00.000-08:00

As we enter the closing week of 2011, a quick review of this year's markets reveals the following:

(1) The US has outperformed. The S&P500 and NASDAQ are virtually flat for the year, whilst the DJIA is up 4.6%.

(2) The USD is still around. The USD has confounded first half predictions of its demise by rising 1% for the year so far, but has bounced nearly 9% from the low it recorded at the end of April. As always there is a direct inverse relationship between the number of forecassers predicting its collapse and its subsequent strength. Look for the same to apply in reverse. There has been a strong inverse relationship between the USD and global stockmarkets.

(3) Asia & Emerging Markets have slumped. In inverse proportion to the rise of the USD, other previously favoured risk assets such as Asia and the Emerging Markets have slumped in local currency terms, and even more so in USD terms. With AAXJ up as much as 5.5% for the year as at the beginning of May, they are looking likely to end the yeardown 17% in USD terms. Some markets, notably former BRIC darlings India and Brazil, have done even worse with declines of nearly 40% and 28% respectively in USD terms.

(4) Europe has done less badly than it should have. Relative to Asia and EM, the main European indices (just to recap, Europe is the place where all the main problems are) have actually performed less badly, with Germany down by about 18% in USD terms, and France by about 22%. Obviously some of the peripherals have done much worse, as have the financial stocks in these countries. However, the UK (which we're not sure should be included as part of 'Europe' any more) is down by only 8% or so. It seems bizarre that the markets where austerity will bite hardest and where the financial problems are most grave, have outperformed their EM growth 'peers', but there you are: "Markets can remain irrational for longer than you can remain solvent..."

(5) Gold has lost a bit of its lustre. Although Gold is still up by more than 13% for the year, it was up as much as 33% at its high point in early September. Margin restrictions on various commodities exchanges were the catlyst for the sell-off but so was an increasing view that deflation, rather than inflation, is more of a problem. As with Asia and EM stockmarkets, Gold also demonstrated that a stronger USD is negative for commodity prices overall.

(6) The US Economy held up better than feared and despite the best efforts of US politicians. This may simply be because the US consumer remains in denial and because everyone was more worried about Europe.

(7) Oh, and European governments haven't got a clue. Enough said.

Looking ahead to 2012, it seems strange to think that the prospects for the year to come look much the same as they have done for the second half of 2011, with many of the same issues seeming likely to dominate. However, our view is that much of the bad news seems likely to be concentrated in the first half (which could reverse the old adage "sell in May and go away"):

(a) The Eurozone will be forced to restructure and rebuild. If they are determined to support the Euro at any cost, then they'll have no choice but to craft a rescue package that finally looks credible with some sort of joint and several guarantee. Maybe this week's action by the ECB to offer 3 year unlimited funding to Eurozone banks is a foretaste of this: the ECB may not be guaranteeing countries, but it is increasingly acting as the lender of last resort to the banks. Once this restructuring happens, although austerity will be the key and widely adopted policy prescription, markets will bounce in the short-term, and probably by a long way out of simple relief that a solution (of some sort) is finally in place. As one of my clients has said, "hope is not a strategy", and its more than likely that more damage will be done on the way there (maybe that's what's needed to get the German government and its voters over the line), but this 'hope' still seems the most likely outcome.

(b) There's a lot of cash out there and markets are vulnerable to good news. A good piece from Merrill Lynch (entitled "I'm so bearish, I'm bullish") this week highlighted that in the 5 weeks leading to December 15th, global long-only fund outflows amounted to $23bn, putting the amount of cash raised close to ML's previous 'buy' signals on a money flow basis. By the same token, $94bn in inflows to money market funds (which produce a zero return currently) over the same period have been the largest such cumulative inflow since the bad old days of January 2009 (6 weeks before the bottom of the market was reached). As we have seen repeatedly, it doesn't take much to get markets moving upward - sharply (even if the reasons for such moves seem impossible to explain at the time).

(c) When risk returns, you'll want to buy Asia & EM, but not before. As in 2008/9, the worst performers turned into the best performers when risk appetite eventually came back.

(d) A slowdown in China may be good news. Slower growth in China is likely to lead to significant easing, and although the impact of such easing will not be as great as was the case in 2009, it will still have a positive impact on the margin.

(e) Beware US politics. The Europeans have set a new standard for political incompetence in 2011, but the divided government of the US has come in a close second. The willingness of US politicos to hold the economy hostage by taking key decisions over the budget, the debt ceiling and taxes to the brink, should not be underestimated.

So, another year of uncertainty and volatility beckons. Although a recent poll of analysts by Barron's shows an average forecast for +12% growth in the US stockmarket next year, the same analysts said the same thing about 2011 at the back end of 2010. So, I think, did we: our mistake was assuming that just because we knew things were tricky, we assumed that this view had been fully discounted by stockmarkets.

What's the potential for yet more mistaken and utterly unjustifiable optimism in 2011?

Probably quite high. There are certainly plenty of "risks to the downside" as they like to say on CNBC. For that reason, for the time being, we are comfortable in maintaining a much lower exposure to equity than normal, and a much higher exposure to cash than usual. Perhaps we also need to be a bit more nimble to book profits as and when they exist and to cut losses on the other side.

However, if the Mayans are right, the world is going to end in 2012 anyway, so what's the point of worrying? Here's hoping that we're all still around to read more drivel from all and sundry (and yours truly) on December 31st 2012!

With best wishes to you and your family for a Merry Christmas and a Happy New Year.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Ummmm... so that's it?

2011-12-11T16:38:00.000-08:00

The much vaunted EU summit has produced exactly the same sort of result that all the previous summits have produced: a lot of hot air but very little by way of concrete results.

For all the sound and fury generated by Britain's use of a veto over potential treaty changes (it seems strange to base the use of the veto on various regulatory issues for the financial services sector, rather than the broader issue of the sovereignty of national parliaments, but never mind), the actual outcome has done little to address the immediate problems.

The ECB will not be acting as lender of last resort, there will be no collectively guaranteed Eurobonds and there is no significant expansion of the EFSF to provide funding for debtor nations. There have been some moves on the margin to allow greater involvement of the IMF but these moves are exactly that: marginal.

Once again, markets will be left to speculate about individual banks and their exposure to sovereign debt, with the likelihood of a messy Greek default in 2012 looking higher. Once again, the very same banks will be reluctant to buy more European sovereign bonds, and once again, they will focus on cutting balance sheets and shrinking lending. The likelihood of a bank collapse remain pretty high, as most banks will remain reliant on their central bank or the ECB for short-term funding support.

The EU rule changes will focus on national budget rules, but there is little detail as to enforcement and penalties for non-compliance. Bearing in mind that France & Germany were among the first to breach the original Stability and Growth Pact and one doesn't hold out much hope that "this time it's different".

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Jean-Claude Van Damnation

2011-11-20T19:31:00.000-08:00

The Prime Minister of Luxembourg, and current President of the Euro Group, Jean-Claude Juncker, summed up the problems of the Eurozone in 2005 with regards to economic reform. His comments remain just as valid today, as the EU confronts the never-ending crisis of sovereign indebtedness within the Eurozone: “We all know what to do, we just don’t know how to get re-elected after we’ve done it.”

As the recently departed Prime Ministers of Greece, Spain and Italy will be able to attest, voters do not respond well to economic crises, and reward the incumbent leaders with a negative verdict at the next election, or parliamentary putsch. The fact that the incoming guys are proposing to implement exactly the same policies seems to make little difference. This approach presumably guarantees ongoing political instability as politicians of various stripes continue to promise the undeliverable (i.e. a pain free restructuring).

The issue, then, seems to lie as much with voters as the politicians themselves, with both moving to the lowest common denominator. Whether its Congressional gridlock in the US (and anyone who thinks that things will change after next year's Presidential election must be delusional), or European politicians who are unwilling to talk publicly about the blindingly obvious (a common currency without common fiscal and monetary policies can't work), each group is running scared of those constituents who seem to think that there is some magic pill for overnight success.

So is dictatorship the answer? As some cataclysmic doom-mongers attest, the last time this sort of thing happened, the only thing that caused a shake out was the Second World War: a cheery prospect.

For the time being, a lot of recent data, particularly out of the US, has erred on the side of "better than expected", whether it be employment / unemployment data, corporate earnings or industrial output. Maybe this is a temporary bounce back from the Japanese Tsunami affected "soft patch" in the middle of this year. However, as a recent note by JP Morgan put it, the fact that interest rates are so low pretty much guarantees that investors won't hold cash long-term, and will be encouraged to dive into risk assets on the merest flicker of good news: hence the current gyrations of stockmarkets between optimism and pessimism between one day and the next.

Not a good environment in which to make long-term investment decisions.

We currently advise continuing patience, hoarding cash, and looking for opportunities on those occasions when pessimism gets overdone. This is not easy nor stress free, and as a consequence those who prefer an easy life should probably retire to Luxembourg.

The Prime Minister there has just continued to notch up records as the longest standing democratically elected head of government in the world (nearly 17 years) - presumably because he hasn't actually done anything worth criticising (in Luxembourg, that is).

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Now for Act 3....

2011-11-01T01:11:00.000-07:00

Last week, the European "comprehensive" package of bailout measures for Greece, the European banks and everything else, was touted by the French and the Germans as the final answer to those doubters who feared that the Eurozone members would never be able to get their act together and agree on anything.

The headline numbers seemed big, at 1 trillion Euros for the leveraged bailout fund (although not as large as the pre-announcement rumours had suggested), and 110 billion Euros or so in new capital for Europe's banks. At the same time, the willingness to acknowledge that Greece is indeed bankrupt and that a default is inevitable, seemed to highlight a new sense of realism, as illustrated by the acknowledgement that a 50% write-down of the face value of Greek debt would be appropriate.

All this helped to boost markets hugely last Thursday. Those sitting on lots of cash were feeling extremely uncomfortable since they were not participating.

However, as so often in the past, a more detailed reading of the terms showed up the usual lack of Eurozone clarity and the presence of plenty of Eurofudge. Exactly how the 1 trillion EFSF is going to be funded seems open to question and reliant on extensive use of derivative products sold to foriegn sovereign wealth funds. Not surprisingly the latter have been decidely luke-warm in their response. The 110 billion in new capital for European banks looks too low, whilst the question about where the new funds will come from also remains unclear.

All this has been followed up by last night's surprise announcement by the Greek government that it is now offering a referendum to its people on the terms of the latest bailout. This laudable exercise in democracy comes at the worst possible time, and takes the whole Eurozone debt crisis into a new realm of uncertainty and worry: if current opinion polls are to be believed, 60% of the Greek voting public would vote against the package.

Clearly a "No" vote would trigger a disorderly Greek default, would represent the death knell for Greece's banks and, most probably, the country's continued involvement in the Euro, along with much else besides. One hopes that the Greek government will be able to get this message across to the voters before the actual vote is held sometime in January.

This then begs the question: why hold a referendum at all? Europe has hardly been a model for democratic affirmation over anything EU related in recent decades, so why start now?

Obviously the poisonous mix of domestic Greek and international Eurozone politics proved too much for the Greek government, faced as it is with increasingly violent street protests and a cratering economy. Maybe this gambit represents the last move in a Greek attempt to extract better concessions from its European paymasters (viz. the Germans). If so, we are now faced with the prospects of seeing which side blinks first: a modern day sword of Damocles.

The European crisis looks as though its going to keep running for a while...

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Our 3 buy signals...

2011-10-04T18:42:00.000-07:00

We've been asked a lot about what we would need to see before starting to deploy cash and get back to being fully invested (or more heavily invested) in equities.

We have three signals we're looking for, and these are:

(1) It's all about growth: Given the sluggishness of the US economy, and the Fed's repeated comments that it is running up against the limits of what it can achieve with monetary policy, we'd need to see a degree of bi-partisan political agreement that has so far been sadly lacking. This would manifest itself in an agreement that the longer term budget and debt issues of the US economy can only be met by pragmatic, longer-term, cuts in spending and increases in tax. These would be balanced by a shorter term job friendly policy initiatives, such as reform of the tax code to encourage companies to start investing again. On a score out of 10 as to how likely this is to happen over the next 6 months, we'd give this a 4/10 since expecting politicians to agree on anything with their opponents in an election year would seem a triumph of putting hope over experience.

The same issues apply in Europe and elsewhere: it goes without saying that if most major economies are cutting spending and raising taxes at the same time, a recession is almost certain. To avoid this, governments need to show a bit more creativity in addressing the issues of restraining debt and deficits longer-term, whilst promoting and supporting growth in the short.

(2) It's all about Europe: The main solutions to the European mess seem obvious: a well structured Greek default, a recapitalisation of the European banking sector and the ECB, and a unified and much larger bailout fund to cope with sovereign debt pressures.

As in the US, however, politics is getting in the way, with the current incremental approach bringing the Eurozone ever closer to a systemic crisis. Maybe that's what is needed in order for (German) politicians to bring their voters with them. Given the immediacy of these issues, the likelihood of this crisis reaching a head before Christmas seems high, although much blood seems likely to be spilt in the meantime. Likelihood over the next 6 months? 7/10

(3) China easing: China has been tightening steadily for the last 18 months, and this has triggered a steady sell off in Emerging Markets equities. If market pundits are correct that China's growth will slow to as low as 0-3% in 2012 from 7-8% this year, the likelihood of easing by China next year seems high, although it's clear they'd like to see property prices lower before that happens. Likelihood over the next 6 months? 6/10 (but 10/10 by the end of next year).

The latter is a big one for Emerging Markets, and would trigger a significant flood back into markets which have underperformed notably in the last three months with foreign investors taking a painful dual hit from the decline in share prices and the decline in currencies against the (recently loathed) USD.

We want to position ourselves for this return of investor interest, but think it's likely we'll see some further weakness in the interim as markets adjust to the anemic global growth story (US analysts are still forecasting 10% EPS growth for 2012...).

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

It's all about growth

2011-09-26T18:03:00.000-07:00

The typical Euroland obfuscation drags on towards an inevitable Greek default, plus an enlarged bail-out fund, plus a further step towards a debt and fiscal union. Eventually a deal will be done, although whether this gets done in a rapid enough time frame to please the markets, remains to be seen. If so, we'll get a continuation of the relief rally that we saw in Europe and the US last night.

However, the bigger issue remains one of global growth.

Whilst a Euroland bailout will help to head off a deeper debt-driven depression, it also means that European governments will be focused on debt and deficit reduction for the foreseeable future. The grudging support of the Germans will require nothing less. Given the size of the public sector as a proportion of GDP in places like Italy, France & Spain, it is difficult to see a major contraction in such spending (often euphemistically referred to as "investment") not resulting in renewed and possibly prolonged recession.

The same is true in the US, where petty politicking has reached further into the reputational sub-basement. The White House has clearly given up trying to achieve an element of compromise in the face of Congressional leaders' opposition to even considering increases in taxes as part of any "grand bargain". Voters will be left to decide on the merits in 14 months, although it remains to be seen whether or not the new Congress that results will give either side the majority it wants to push through their favoured proposals.

As a consequence, we will be stuck in a short term cycle for some time, in which the focus is on monthly data which purport to show the onset of recession or otherwise. That means the US employment data on the first Friday of every month will assume totemic importance, as will the monthly global purchasing managers' index data which is released around the same time.

As if we needed more, it seems as though volatility will be with us for a while.

For example, it is notable that this month in USD terms, non-Japan Asia has been the worst regional performer, with the AAXJ index in USD's down by 16.9%, compared with a drop of 'only' 12.9% in the MSCI Europe index. One would be hard pressed to explain the logic for this given that it's Europe with the major debt and banking crisis, not Asia/EM.

Nevertheless, this highlights that the high beta Asian and EM markets remain very vulnerable to sentiment driven flights from risk, partly because of leverage being unwound (lots of investors had bet on further structural weakness in the USD and shorted it accordingly by buying Asian shares in local currency), partly because of fears that the Asia/EM exposure to a slowdown in trade would result in any Europe/US recession arriving almost as quickly in those economies (just look at the gyrations in Korea this month), and partly because in any crisis foreign investors simply take their money back home dumping anything foreign.

Obviously, the flipside is that these same markets have strong recovery potential as and when volatility eases. In 2008 AAXJ dropped by 52.2% in USD terms. In 2009, they jumped by 72.5%.

On present global market form, however, that jump could be some way off.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Killer currencies

2011-09-22T17:36:00.000-07:00

The moves in equity and other markets has been bad enough.

However, adding insult to injury has been the sharp flight away from previously favoured currencies and back into that pariah of the (very) recent past, the USD.

To put this into perspective, the USD index was down 6.6% for the year to date as at the end of August: pretty much at its all time low. in the last three weeks the USD index has risen from 74.24 to 78.23 as of last night: a jump of 5.4% (albeit still down 1.3% for the year). The logical reasons for the weakness up to end August were several:

(1) Low bond yields made the USD relatively unattractive
(2) The Fed's continued commitment to a loose monetary policy meant that the official stance seemed to favour a weaker USD
(3) Political and economic sclerosis

The fact that, until the last few weeks, even the dire position of the Eurozone did not result in a flood away from the EUR, was illustrative of market perceptions, that in the "ugly contest" the reasons for hating the EUR were evenly balanced by the reasons for hating the USD.

The last few weeks have seemingly changed all that. Now, it's a question of forget the fundamentals, minimise the risk. In that environment, as we saw in 2008, it's the USD which is the favoured currency of choice. During that period of extreme stress the Dollar index moved from 71.5 on July 16th 2008 to a high of 89.6 on March 4th 2009 - an overall move of 25%.

It then proceeded to reverse most of that rise in the subsequent 7 months.

These moves are extreme and very rapid: not for the first time, does it feel as though markets of all types discount the best and worst of news in a time frame that previously seemed to take months or even years. There are plenty of reasons for this, but the end result is that it makes the job of perfect foresight even more humanly impossible than it was before.

We don't aim to predict short-term currency moves since we are not currency speculators. We do feel however, that, on a longer-term view the currencies of Asia and the emerging markets are in better shape and worth holding: government debt and deficits are manageable and not confronted with major structural problems, the economies are growing and consumers are spending. Painful as it is, we aim to tune out the currency noise whilst focusing on those core facts: if anything, we'd aim to buy more of these if weakness persists. At some point they will rebound. That moment will come when all the banks (which were aggressively short USD's last month) go long USD's.

Given the speed with which things are moving, that could be by the time I've finished typing this sentence.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Twist & shout

2011-09-21T16:11:00.000-07:00

So the Fed has now come up with its latest wheeze to try and kick start the flagging US economy: the so-called "Operation Twist", which seeks to help bring down the yields on longer dated bonds by purchasing these as the Fed's current holdings of short dated Treasuries mature.

Whilst the Fed can't be blamed for trying, the base fact is that it is left with few powerful weapons in its locker, and is reduced to tinkering on the sidelines of the main event. As the Fed Chairman, Ben Bernanke, highlighted in his speech last month at Jackson Hole, the Fed's use of monetary policy is reaching the limits of its effectiveness and it is now up to the two year olds in Congress to come up with fiscal policies to address the current problems.

It's not an issue of the cost of borrowing: the Fed has reduced interest rates to almost zero and loan demand has remained anaemic. The core problem is a weakness of demand and therefore a weakness of sales: without either of these two things, few companies will be encouraged to make use of their substantial cash balances to invest in new capacity or the creation of new jobs.

Such a lack of confidence reflects the poor quality of political leadership in the US and Europe.

The two main parties in the US appear to have given up trying to reach any form of compromise, preferring to posture in front of their narrow bases, and ahead of an election that is still 14 months away (if you thought the election season of 2008 seemed looong, you ain't seen nothin' yet). In the meantime, of course, the economy will continue to flag, increasing the likelihood of a new recession, for which politicians of all stripes will share an equal element of blame.

In Europe the situation is as bad or worse.

It has been clear to virtually everyone for a long time that a Greek default is inevitable. The repeated attempts to force swingeing spending cuts on the Greeks do little, particularly when the consequence is simply to deepen an aleady severe recession in Greece. Such policies further postpone its ability to pay the interest on the new debts it is taking on (and don't even talk about repayment of the principal).

This week's edition of "The Economist" has an excellent analysis of the problems facing the Eurozone this week, and a possible solution. Not surprisingly, this focuses on the need for the Germans to get over their (understandable) annoyance about bailing out the profligate Greek beach goers and recognising that a managed default is ultimately preferable to the alternative: a disorderly default and the collapse of the Euro. The Germans, more than anyone else, have too much invested in the project to let it die (as an aside, don't forget that it was Germany and France that first bust through the deficit limits underpinning the Euro in the mid 2000's).

The disquieting thing is that politics is driving the timetable.

One gets the sense that the politicians are waiting for a greater sense of crisis before they have the courage to present the truth to their voters. In the US this means spending cuts and tax increases (otherwise the "Math" just doesn't work). In Europe this means fiscal union with a collectively guaranteed Eurobond to underpin the borrowing costs of all Eurozone members, but with far tougher enforcement and compliance from a German-led European finance ministry.

Will this happen? Probably, but the crisis could get worse in the meantime.

The only saving grace for investors in markets is that interest rates are not going anywhere any time soon. Any hint of adult leadership will result in this money sloshing in from the sidelines with nosebleed inducing speed.

Keep the tissues handy.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Bloody markets

2011-08-21T18:30:00.000-07:00

Since the beginning of August, global stockmarkets have fallen by 13.2%, and a temporary rebound between the 11th and the 15th proved short-lived. As of last Friday, global stockmarkets are back down to their lows for the month. Most markets have moved into the zone of a technical correction (a drop of more than 10%), whilst some are now in official bear market territory (-20%). Market moves that used to take months to play out are now occurring in the space of days or even hours.

The sharp falls of the last few weeks reflect the rapidly heightened concern amongst investors over the reluctance of politicians to recognise the depth of the problems confronting them, with the result that the crafting of solutions has been left to central bankers, who are stretching ever longer the limits of their official remit.

The ECB is getting deeper into the mire of supporting the sovereign bond market in Europe, whilst the Federal Reserve in the US has made a commitment to keeping real interest rates negative for the next two years.

Regrettably, however, both central banks are now getting to the point at which they can do little more. The recent experience of the US with QE2 bears this out: printing money has had little effect in helping to boost the economy, since if consumers and companies don't want to borrow, it doesn't matter how low lending rates go since it's not the price that matters any more... it's the perception of risk. The problem is not one of liquidity.

In Europe, the ECB can absorb sovereign debt issues without end, but lacking a collective and explicit guarantee from all Eurozone countries in support of future loans, eventually the ECB will run out of capacity and widespread sovereign defaults become inevitable. It may be that, at that point, the rest of the Eurozone will rally around with the necessary guarantees. It will take a crisis to get there.

In any event, a global recession now seems inevitable, given the limited policy tools available to governments and central bankers to prevent one (try getting another stimulus package past the Tea Party in the US, for instance). It therefore needs to be said that expectations that the recent "soft patch" in economic data would turn round, prompting a continuation of the gradual recovery now look optimistic (you might want to preface "optimistic" with the word "hopelessly"). We have been as guilty of that as anyone else.

It goes against logic that - post a Eurozone debt crisis and the recent US fiasco over the lifting of the debt ceiling - if developed world government spending accounts for more than 1/3rd of GDP and that is financed by deficit spending which needs to be cut, government spending across the board is going to be cut, whilst taxes are raised simultaneously. With private sector demand still anemic and fearful, the slack won't be offset by increased demand from elsewhere, so - by definition - global GDP will decline. China and the emerging world are not in such bad shape in debt terms, but they are exposed to slowing global trade, so they too, will be affected.

We then get on to the point of trying to determine how big and how long will the recession last, and how much of this has been discounted by stockmarkets? In addition, with interest rates so low, do these provide a degree of support for risk assets that have not been a feature of previous recessions?

On the first - not being an economist - I'd admit that this is complete guesswork (maybe economists should admit this too...). However, logic suggests that any deficit and debt reduction programme will talks years no months, and that this will drag on economic growth for a while. It may well be the case, however, that greater clarity will eventually encourage the private sector to begin deploying its cash thereby limiting the depth of the recession itself. In this, prevailing low interest rates will eventually help, as will a marked falling off in inflation.

What's less easy is to determine how much of this recessionary risk is now discounted by stockmarkets.

John Mauldin, in his online weekly "Thoughts From The Frontline", suggests that on average, stocks drop more than 40% in a recession. He also notes that with the recent economic data from the US looking pretty grim, markets have further to fall as do bond yields. If he's right than the corrections we have seen thus far in stockmarkets are a foretaste of further declines, and that any bounces we see on the basis of short-term policy fixes (like the one that may well accompany Bernanke's policy speech this week from Jackson Hole), should probably be sold into. As Mauldin says, we are now at the point where "not much can be done, other than than just get through it as best we can. [Since] this will offer some very interesting opportunities, I am not one for digging a hole and crawling in it".

To paraphrase Oliver Cromwell, you may keep your faith in God, Ben Bernanke, the ECB, Angela Merkel etc., but keep your powder dry. The markets we're looking at closely would be those that will benefit from reduced inflation and increased consumer demand at home: Asia, India, China etc (the latter two having underperformed for some while), luxury goods themes, commodities and high yield fixed income on further weakness.

Steve

Now what....?

2011-08-08T17:29:00.000-07:00

Every morning we update a table of data on the daily movements in markets, commodities and currencies (if you want a copy let us know and we'll put you on the daily distribution list).

It also now shows the damage that has been done to markets since the beginning of the month: world equities down by 13.2%, the S&P 500 down by 13.4%, Europe -14.5% and Asia Ex-Japan -10.4% (the latter probably understated since we haven’t seen what Asia will do today in reaction to last night’s Wall Street / European sell-off). What it also shows is the big declines in some commodity prices: Brent crude oil now down 11.2% for the month.

The gains have been equally noteworthy: Gold up 5.8% to yet another all time high, the USD index up 1.3% and the US 10 year Treasury yield (remember the downgrade?), down 16.8% to 2.339% (the yield moves inversely to the price, meaning that the 10 year Treasury price has gone up to reflect the “flight to security”).

We’ve been saying in the last few months that we agreed with the US Fed’s assessment that the US Economy’s current “soft patch” will improve in the second half of 2011. Obviously that’s now looking (much too) optimistic, even if that argument may have been temporarily helped by the recent fallback in commodity prices which will reduce inflationary pressures worldwide. For Asia and the emerging markets which have been grappling with sharply rising prices over the last 12 months, that’s actually a positive. That’s the good news.

The bad news is not the US debt downgrade.

The bad news is that with markets forcing the “developed” world debt story ever more sharply front and centre in recent weeks and days, the heightened pressure for major austerity programmes being imposed on unwilling governments will mean ongoing and significant public sector spending cuts at a time when private sector spending remains anaemic. Politicians will have no choice but to think about something other than their re-election for a change. Bloodbathing stockmarkets won’t help to boost private sector confidence and encourage either companies or consumers to spend.The likelihood of a renewed recession later this year or in 2012 has just risen several notches from "remote" to "probable".

What could change this negative feedback loop?

Central banks will obviously be reaffirming their plans to keep interest rates down for the foreseeable future. This could mean we won’t see interest rates increasing until well into 2013 and then only if the economy and employment starts recovering materially. Aside from that, it is also clear that the Europeans will be pushed ever more closely into formal fiscal union, whether the Germans like it or not: the ECB’s program of buying Spanish & Italian debt is the latest step in this direction. The alternative is the dismantling of the Euro a prospect which the Germans seem to like even less.

In Asia and Emerging markets, reducing inflation is good news, although any double dip global recession will hurt the trade flows on which Asia is dependent.

So what do we recommend for this month?

I’d like to think that we’re being presented with a good buying opportunity, especially in Asia and EM, especially given the prevailing low level of interest rates: holding cash on a longer – term basis is not an option.

However, now is not yet the time, I think: short-term panic and nervousness could likely mean more short-term weakness until markets reach a level that prices in a Recession. Not good for mental health or sleeping well.

Never go on holiday...

2011-08-04T17:23:00.000-07:00

August is traditionally a time when Europe takes the month off. In the UK, for instance, the Prime Minister, the Deputy Prime Minister and the Chancellor of the Exchequer are all away this week, leaving the government in the hands of the Foreign Secretary. Last week, however, the Spanish Prime Minister delayed his vacation departure date in the face of growing concerns about Spain's fiscal position and spiking Spanish government bond yields.

It all seemed so different a few weeks ago, with the latest Greek bailout package agreed only on July 21st and the US stepping back from the brink of worsening a self-inflicted injury over the debt ceiling.

The reverse, obviously, has been the case.

Recent US economic data has been weak (tonight's non farm payroll numbers will be critical), thereby either extending the life of the so-called economic "soft patch", or making a double dip recession in 2012 more likely, depending on your point of view. The Purchasing manager's Index (PMI) data last month, on a global basis, also looked pretty lacklustre, with a marked slowing in the Eurozone - even in previous powerhouses like Germany - and China.

Concerns about the spreading of the Eurozone debt crisis to envelop Spain and Italy have charged to the fore, thereby severely testing the political will and financial resources of those in the Eurozone tasked with holding a series of ever retreating front lines.

What is clear is that the ability of central banks and governments to step into the breach is much more limited than in 2008/9 at the time of the Lehmans melt-down.

The political focus on debt reduction and austerity spending cuts in the developed world now limits governments' ability to further offset any continuing weakness consumption spending and in the private sector. Similarly, with banks remaining politically toxic, the possibility of further bailouts looks remote in anything other than the most extreme cases.

As Gillian Tett points out in today's FT, the parallels with 2008 look uncanny: starting with pronouncements that the problems in Greece (for which read "Sub-Prime" in 2008) were not sufficiently large to put the system as a whole at risk etc.

The behaviour of markets yesterday suggest that many market participants are choosing to shoot first and ask questions later.

Since July 22nd, the day after the latest Greek bailout, the MSCI World equity index has fallen by 10.3%, putting it in official "correction" territory. The dollar has recovered some ground and gold has risen to new highs.

So - what's our view?

(1) We have long held that the second half will see a recovery from the "soft patch". This is starting to look optimistic, but won't be proven for another month or two. The problem, of course, is that by the time the data comes through, markets will already have discounted either the good or bad news: the current market rout has been concentrated in the last 6 trading days. Tactical market calls are therefore reduced to guesswork.
(2) Europe's problems are reaching an end game since Spain and Italy are simply too large to bail out (see the chart below from JP Morgan). Weaker members will have to be allowed to default since the levels of debt in Greece, Ireland and possibly Portugal are simply too large relative to the size of their economies. Some recapitalisation of Europe's banks seem likely in that scenario (hence the severe weakness in their share prices over the last month).

(3) Global interest rates will remain close to zero, despite inflationary pressures (which we do expect will ease in the second half).

(4) Corporate earnings growth, so far, has been very healthy. Although this maybe of only academic interest if the banks start teetering again, an interesting piece from JP Morgan last week reiterated that their forecast of a 9% jump in the US market by the end of the year was at the low end of market forecasts (as at the beginning of May). With the falls of the last three days taken into account, that would seemingly now translate to forecasting a 15% rise from their current - more depressed - levels.

So - sell, buy, or sit tight?

Aside from the back end of 2008, the best tactic in recent bouts of market volatility has been to ride it out. The question, therefore, is whether or not we are facing another "back end of 2008 scenario" over Europe. Debt and democratic dysfunction in the US will not help.

We hope not, but there is no doubt that we're in for a difficult month, since nothing short of an implosion will be enough to encourage European leaders to cut short their trip to the beaches, thereby prolonging the vacuum of leadership. As we saw in 2008, what seems limited in scope and short in duration can be driven by markets to a much more painful reality.

Even if leaders do come back from holiday, their recent attempts at structuring rescue packages have consistently fallen short of the "big deals" the markets now seem to feel is needed in an environment when global growth is sluggish.

Crafting long term investment views in this type of environment is either difficult, or somewhat pointless.

What is obvious, though, is that downside risks have grown over the last few weeks and that these now look larger the upside potential. In that environment, sitting on cash or very well diversified portfolios seems both prudent and appropriate. Not time to be brave yet.

Yippee. Deja vu all over again.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Deja Vu All Over Again

2011-07-17T18:59:00.000-07:00

Lurching markets in June & July still look like a carbon copy of last year when we had similar discomfort in May and June over similar issues (Euro debt / US growth).

Given the growing size of the issues at stake, though, it's been a surprise that markets have not fallen more sharply: we've said before that this is as much a function of the lack of real investment alternatives to equities as anything else (cash and fixed income returns are low or negative in real terms, and this seems unlikely to change any time soon, unless you feel the urge to load up on Greek debt?).

There's no doubting, though, that sentiment remains extremely nervous as we saw by last week's bear raid on the Italian bond market and the sharp drop in the EUR.

The spectacle of Eurozone politicians and officials failing to produce a credible long term solution to the problems of the periphery is growing ever more pathetic, notwithstanding the difficulties of resolving the diametrically opposed political and economic objectives of the Germans, the French, the ECB and the debtor nations. Although a managed default by Greece (and possibly Ireland and Portugal) seems inevitable and unavoidable, achieving this without triggering more widespread contagion and a possible break up of the EUR looks beyond the wit of the current bunch of "decision makers".

Speaking of turkeys, the current "debate" in the US between the equally intransigent Democrats and Republicans is every bit as unedifying as the squabbles and indecision in Europe, as we head closer to the August 2nd deadline for raising the US debt ceiling.

Once again, the effect of this on markets has so far proved virtually non-existent (the yield on ten year US treasures has actually dropped below 3%), on the basis of the widely held assumption that "something will turn up" in true Micawber style. One has to assume that this will indeed be the end result, since the prospect of a government default and shut down will do little for the credibility of either side.

The fact remains of course, that the debt problem is so large that both spending cuts and tax increases will be required. Both sides know this, but distilling that into a 5 second soundbite for Fox news is proving challenging.

To put this into perspective, take a look at these charts from JP Morgan:

The first shows the steady rise in the debt ceiling since 2006, and the % of GDP accounted for by that debt... after a trifling 100% of GDP and about $14.3tn. The proposed increase would take it up to 109%. With the help of this week's 'Economist' magazine, the need for budget cuts becomes ever clearer:

The US's primary budget deficit as a % of GDP is the largest of all the major developed economies: without rigorous action to bring this under control, the problems will simply grow ever larger due to the nature of spending commitments on Medicare, Medicaid and Social Security, and the reality of demographics in an aging society.

In the past, the US has always relied on growth to help push these problems into the background. Not any more: sluggish growth and productivity improvements have meant that US companies can do more with fewer workers (which is why the current Q2 results season is once again exceeding expectations), whilst tax revenues slump due to the moribund state of the US property market and consumer spending.

No corresponding cut in spending or increase in tax rates results in the US is living beyond its means. As a result, commitments made in the good old days when the US economy dominated the world must now be renegotiated, as shown by JP Morgan's second chart which illustrates the present value of future entitlements. These make the current debt of $14.3tn look like chicken feed.

One assumes that some form of reason will prevail, and a mutually unacceptable solution will be found, although in true "Turkeys voting for Thanksgiving / Christmas / Festivus" style, rabid tea-partiers, signatories to Grover Norqvist's "no tax increases" pledge, and spendthrift Democrats might just feel that a default is their only alternative if they want to get re-elected. Never mind the country's credit rating, or doing the right thing. It's all looking a bit like Europe.

We're still of the view that a resolution will occur to both the EU & US deliberations since there are signs that all parties involved are getting the point. Watch for creative solutions in the next couple of weeks (the Europeans will want to get it sorted before they take August off). On that basis, we still hold the view that markets will stage a rally in the latter part of this year.

Hopefully.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Javelin's Investor Seminar

2011-06-19T20:59:00.000-07:00

We held another of our semi-annual investor seminars last week at the Singapore Cricket Club on June 15th. Our three speakers were Michael Preiss, the head of equity strategy for Standard Chartered Wealth Management, Richard Whittall, the Singapore based partner for the Fabien Pictet & Partners group, and myself.

The Standard Chartered view was bullish on gold, but seemingly little else, as Michael recounted his thoughts on the Eurozone meltdown, the US economy and global debt. No quick fixes.

Richard gave a thoughtful presentation on his experiences following the Japanese stockmarket since the late 1980's. He noted - obviously - that the Japanese market has been a dreadful performer since it peaked shortly after he started looking it, but that there are still some great companies that have prospered notwithstanding. Interestingly, he highlighted a number of those that are good proxies for Chinese growth, since they produce products that are helping to fuel the expansion of the Chinese manufacturing sector.

Our view was one of highlighting that, so far, we view the current market performance as a carbon copy of last year - a sell-off in May/June on the back of worries over US growth and Eurozone debt, but with a stronger second half. Most particularly our view is dictated by the prevailing low interest rate environment, which gives few options for pursuing real returns, particularly from cash. As a result, any market sell-off seems likely to be short-lived as this sidelined cash moves back into markets. We liken this to a bath full of water: when tipped up, the contents slosh in one direction before sloshing back again.

This is not to say that we under estimate or under play the headwinds or the bizarre approach of most politicians to ignore the longer-term debt and spending issues - which can only be resolved by a long bout of spending cuts and reductions in ultimately ruinous entitlement programmes and public sector pension programmes - but that the market's preoccupation with finding a short term home for unproductive cash means that these big picture issues will be pushed aside for consideration at some other time (as to when that will be is any one's guess).

Until interest rates rise to the point at which holding cash presents a real investment alternative (as opposed to just avoiding short-term losses), risk markets will continue to provide the main focus.

Have a good summer break!

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

A summer slide or a correction?

2011-06-06T17:32:00.000-07:00

Last Friday's disappointing US non-farm payroll employment numbers for May have highlighted that the US economic recovery remains anaemic. Although these figures are notoriously volatile (and subject to change), stock markets have clearly taken these to heart, adding to a slide that has taken world equities down by more than 5% since May 2nd.

It seems that the "Sell in May, go away adage" is obviously proving correct. It also seems to be doing so for the second year running.

Between the end of April and the beginning of July last year, US indices fell by a total of 16%. In 2010, the reasons for the market's weakness were similar: kicked off by the so-called "flash crash" on May 6th (when the Dow fell nearly 7% in a span of 47 minutes), sentiment was undermined by worries about the US economy and concerns over European debt.

Sound familiar?

Last year, the remedy was government and central bank action which resulted in the announcement of QE2 in August and the first of many rescue packages for indebted Eurozone members (Greece and Ireland). As a consequence, after the early summer bloodletting, US indices rebounded to finish the year up 12.8% overall and by 23% from that mid-summer low point.

So what's different this time?

The US economy is still anaemic, but the Federal Reserve would seem to have less room for manoeuvre than was the case a year ago: a third round of QE would be politically tough with Republican deficit hawks in control of the House of Representatives since last November. These upstanding individuals are already slavering at the prospect of bringing the Fed to heel, and a third round of QE, whether necessary or not, would ensure further support for this.

It is also unclear as to whether or not QE has actually achieved its objective, if that objective is defined as anything other than boosting the stock market. In reality, banks have simply sat on the ‘extra’ cash and, as a consequence, credit growth has continued to struggle. Banks remain more concerned about repairing their balance sheets rather than in making new loans to businesses or homeowners (in the case of the latter, there is no evidence that the housing market is starting to recover). Banks may have received cheap credit from the government but continue to feel that this does not place them under any social or national interest obligation.

In Europe, by contrast, nothing seems to have changed. The Europols still seem in institutional denial about the likelihood of a Greek default - sorry, "reprofiling" - whilst ensuring that enough money is lent to the struggling country to enable the whole thing to be deferred for another 9 months or so. Borrowing more money to repay the principal and interest on the loans you already have is clearly a well thought out, sustainable, long term strategy. It would seem that the 80,000 or so Greek protesters who took to the streets last weekend might have other views.

So - there are plenty reasons for markets to be unsettled. Again.

It is also the case that such concerns are valid enough to continue depressing markets for a little while longer, particularly if the global economic data continues to be sluggish over the next few months (as a result, for instance, of the after effects of the global supply chain shocks from Japan being obviously under-estimated).

For how much longer and by how much more markets could fall, is, quite frankly, anyone's guess.

What seems clear however, is that, like last year, rebounds in markets can be equally dramatic. We have been continually surprised at how markets can lurch around. From depression - where all bad news is viewed as cataclysmic. The bottom is usually heralded by Nouriel Rubini forecasting meltdown on CNBC, and Richard Russell's charts forecasting a 50% market decline. To euphoria - where all bad news is viewed as being "in the price" and with central banks doing "whatever it takes" by flooding the system with more cash.

Most particularly, however, the one major thing that hasn't changed is that a sluggish global economy will result in inflationary pressures tailing off (particularly once the year ago price comparisons are no longer a feature) and interest rates remaining at very low levels.

It's interest rates, we think, that remain the key to market performance: investors won't (and can't) sit on cash for very long since the real returns from holding cash remain negative. The slightest evidence that the global economy is recovering poise will result in that sidelined cash charging back.

So the question is, although it's easy to sell now, can one be sufficiently prescient to spot the appropriate point at which to buy back in? Extensive studies of market sentiment suggest not: the biggest market outflows (selling) by retail investors take place just at the point when markets bottom, whilst the biggest inflows (buying) take place at the top.

For our part, we feel that the summer sell-off looks, at present, like a bout of "healthy profit-taking", and are occurring at a time when volumes are seasonally lower. We like having a bit of cash to play with to pick up cheaper equity ideas, but are not running for the hills and stocking up on canned food.

At least not yet. The world is not scheduled to end until 2012, right?

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Owe Money, Pay Money - Greece and the loansharks

2011-05-30T18:17:00.000-07:00

When illegal loan sharks in Asia want their money back from someone who has fallen behind on their payments, a traditional tactic is that they daub signs on the front door of the house concerned: "Owe $, Pay $". They rely on public shame to force a response.

The flip side, of course, is what happens when public shame doesn't work. Sometimes the borrower can end up receiving a rather more direct and painful reminder.

Although you could argue that Greece has borrowed money from far more reputable sources than mere loan sharks, it is still facing the same difficulties as other overstretched borrowers, and runs the risk of meeting with similar discomfort. It remains to be seen whether it's going to get beaten up, or if its lenders will have a change of heart: as John Paul Getty once said, "if you owe the bank $100, that's your problem, if you owe the bank $100 million, that's the bank's problem". The fact that we're talking a few $100 billion here is the merely the difference of one letter, so who's counting?

What we have here is a clash between Euro economics (the Greeks can't pay) and Euro politics (the Germans won't lend), and it's by no means clear which side will end up on top.

The most likely end scenario, is - of course - the usual Euro fudge.

However, we've cobbled together summaries from a couple of commentaries (the first from the WSJ, the second from ING) which seem to give a reasonable run down of the options available to the Greeks and their European 'partners'.

This morning's column from the WSJ notes that Greek bond prices have been reflecting the increasing likelihood of a default for a few months now: the current yield on Greek 2 year debt is 25%. The yield on Germany's 2 year debt is about 2%: a difference of a mere 23 percentage points (the difference between borrowing from your mother and borrowing from Mastercard or Visa).

If you didn't think Greece was going to default, obviously you'd be loading up on Greek paper like it was the latest hot item in a teenager's wardrobe.

The market is therefore trying to tell us something about the likelihood of a Greek default (now referred to as a "re-profiling" rather than a "rescheduling" or "default", as if that helps to make it more acceptable - semantically).

Last year's EU led bail-out of Greece was supposed to see the Greeks through, without the need for any further cash, till 2012 (although nobody really believed that at the time). To the surprise of no-one, they're actually going to run out of money in July. Of this year. That's two months from now.

The key thing here, is that Mr. Getty was right: it's not really a Greek problem anymore: the European banks are in it up to their necks, as is the ECB: all of these have taken Greek bonds as collateral for further loans, and any "re-profiling" would likely result in such bonds no longer being treated as acceptable capital. If that's the case, the ECB ends up being insolvent and the Euro banks end up needing a lot more capital. The lack of transparency about how much Greek debt these groups actually hold is not helping.

It's also not just these groups: many fund managers who hold the debt of Greece (although we haven't come across anyone that actually admits to having any) or Portugal or Ireland, are not allowed to hold debt that has been downgraded to 'junk status', and, in the event of a Greek default, they'd have to offload into a market where few buyers exist at prices that are not well below their cost (think 60% below). That would have big ramifications for the debt markets as a whole and high yield in particular (we saw at the end of 2008 what happens to the price of high yield when the buyers disappear).

Since these - possibly unintended - consequences are too grave for any central banker to contemplate, there seems to be little alternative to their moving in the direction of a Euro fudge. A recent report from ING contemplates how this might happen:

Stage 1: The EU finds a way to lending the Greeks some more money in the short-term whilst they spend the summer arguing about a more robust long-term solution. Obviously this has to be done without the Germans or the Finns backing out. In return for this cash, the Greeks will likely have to privatise everything that's privatisable, and sell off the Parthenon to China. Obviously this has to be done without the Greek populace objecting.

Stage 2: The EU will have to find a way to restructure (sorry, "re-profile") Greek debt, by extending its maturity, by cutting the interest cost, by swapping the current stuff for longer dated and lower cost debt, or a combination of all three. And they have to do this without the rating agencies treating such a shuffle as a default.

Stage 3: Greece reforms its economy, gets three jobs, works overtime, brings its costs down and gets more competitive, thereby enabling it to gradually reduce its debt burden as the growth generated by such hard work helps to raise sufficient money to pay off its creditors.

Alternatively, it hits the Ouzo and takes off for the beach.

Alcohol and the beach represents the unilateral option: that of Greece defaulting unilaterally, exiting from the Euro altogether and going back to the Drachma. This would be the "nuclear option" that would shut Greece out from the capital markets for a generation or two, scupper the Euro project completely, whilst causing the ECB and the Euro banks the same problems with worthless collateral as outlined by Mr. Getty in the third paragraph above.

Even Germany would probably prefer lending the Greeks more money than contemplate having to bail out the ECB and the European banking sector (again).

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Summer time out

2011-05-26T17:19:00.000-07:00

The surprise is that it's a surprise. The "news" that Greece is having trouble meeting its punishing commitments for spending cuts and tax increases is a fact that was obvious before the ink was dry on the various agreements with the EU, ECB and IMF. Ireland's no better off, whilst the Portuguese and the Belgians don't have a real government so no-one knows what's going on.

The shrill protestations from the ECB that Greece will not be allowed to default or reschedule look equally unsustainable: the Greeks can't pay (because, as the UK Labour Party's outgoing head of the Treasury said in a note to his successor last year: "there's no money left").

As we've said before, the end result of the Greek fiasco will inevitably be some sort of EU fudge - the latest possible wheeze being that instead of calling it "default" or "rescheduling", the new term will be "re-profiling": As BusinessWeek points out this week, that's the Eurospeak equivalent of referring to murder as "terminating with extreme prejudice".

In broad terms, it just looks as though it's Europe's turn to come under the spotlight for a while, and that's the reason for the Euro falling by nearly 5% against the USD this month. The US is hardly in better shape, and neither is the UK, or Japan, but the major currencies can't all be weak at the same time, even though, in isolation there are compelling reasons why they should.

What does this mean for markets over a hot and bothered summer?

The US markets are down about 3% or so this month so far, whilst in Europe the figure is about 6.5% (half of that is attributable to the fall in the EUR), and Asia is down 5% or so. The headline falls in commodities this month have been led by silver (-21%) and oil (-9%), although of late these seem to have stabilised. I was at a seminar yesterday where some bank strategist again talked about Asian markets "de-coupling". Obviously he hasn't registered the fact that the markets are inconveniently doing the complete opposite - correlation is alive and well (Asia remains the high beta market play).

Our sense is that the Eurozone crisis will continue bubbling away with markets continuing to speculate about the Greek problems (not for nothing did Virgil have the Trojans coining the phrase "beware of Greeks bearing gifts...") and the probability of a default which won't be called that. As before, ultimately, the Europeans will fudge the issue and likely change the rules so that the impact of the "not a default" will be more limited than the rules currently allow for. Once that's dealt with, then the spotlight will move on and markets should see a gradual recovery.

In general terms, even though the headline rates of GDP growth still look anemic (the robustness of the German economy providing the obvious exception), corporate earnings still seem to be coming in above expectations. Interest rates still seem likely to be held at low levels, particularly so as the effect of commodity price rises and tax increases (VAT was pushed up by 2.5% in the UK at the start of 2011), begin to fade away from the year ago comparisons.

Easing inflation should be good news for markets generally, with some such as India and China beginning to look more attractive as and when those inflationary pressures begin to ease. In the developed markets, we still favour the US. We have been underweight Europe for a long time, and there remain good reasons for being so. Having said that Germany remains attractive particularly if the Euro continues to fall back: at that point (say around the $1.30 level on the USD) not only does the market look interesting, but foreign investors also can gain on a recovery in the currency.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, www.roomtoread.org and the Singapore Children's Cancer Foundation www.ccf.org.sg.

QE2 - The end of the voyage

2011-05-15T20:06:00.000-07:00

We were sent a good commentary piece recently by FX Concepts - the headline was "What happens when QE2 ends?": highly topical since the US Federal Reserve has already announced that it will conclude its "large scale asset purchases" by the end of June. The liquidity that the Fed has been injecting into the system since the beginning of the Quantitative Easing programme has been an important factor in supporting sentiment (if nothing else) since the beginning of the first QE programme in March 2009. Since this programme coincided with the bottom of the market earlier that month, it's a legitimate question as to whether the ending of the latest programme - QE2 - at the end of June will represent a topping out of markets as either liquidity stops growing so dramatically, or is withdrawn over time.

The FX Concepts piece describes the situation well. They note that in the last 3 months, Fed purchases of US Treasuries has soaked up 94% of the Treasury's total issuance of debt in the form of Bonds and Bills. That leaves, apparently, less than $10bn a month to be absorbed by "the market". Obviously from July 1st, then, "the market" will need to subscribe to an additional $157bn in order to take up the slack. Ordinarily, once would assume that interest rates will have to rise to encourage such investors of the attractions of such debt, particularly in comparison with places like the Eurozone, where the ECB has already begun tightening.

FX Concepts, however, makes an interesting point on the USD: what happens to it when foreigners are being expected to increase their purchase of USD debt...? Normally, increased large scale foreign purchases of US assets to the tune of an extra US$157bn a month, could be expected to boost the USD: for the same reasons that the Fed's purchases replaced foreign buyers with a single domestic one and resulted in steady USD declines through out the period of QE/QE2.

FX Concepts also notes that on a global basis, the withdrawal of this excess liquidity means a squeeze on the availability of money and therefore higher interest rates: not good news for struggling property markets in the US.

If the withdrawal of the Fed as the main buyer of US Treasuries puts pressure on the banks to be more aggressive in lending in order to replace the risk-free revenue they are losing, then the positive trade-off could work well. If not, and interest rates go up, with no corresponding increase in lending, then the global economy could go into a stall.

Big stakes. Maybe we'll know in July which way things are going to go...

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, www.roomtoread.org and the Singapore Children's Cancer Foundation www.ccf.org.sg.

Where next...?

2011-05-02T23:40:00.000-07:00

I read a good piece from Damian Kestel of CLSA this morning, entitled "The last 15%":

The last 15%. Both the S&P 500 and the MSCI Asia ex-Japan index are within just 15% of their all time highs. [This is] incredible, considering the carnage that took place and the major issues that still exist, but not so incredible considering the amount of money that has been thrown at the problem – not to mention the persistently low interest rates that have been in place for sometime (the Fed Fund Target Rate has been 0.25% for coming up to 2 ½ years). What is also somewhat incredible is that the VIX index went below 15 late last week for the first time since mid-2007 considering the issues the world faces.

Damian goes on to quote a note from the analysts at GaveKal:

“One of the more amazing features of the performance in equity markets this year has been the continued lack of volatility. Investors who had placed bets on the VIX as a hedge against potential 'black swan' events must by now be wondering why they bothered. After all, we have recently witnessed: a) a tragedy in the world's third-largest economy with consequent disruptions on global supply chains, b) an eruption of political unrest across the Middle-East and a surge in oil prices, c) continued acceleration of inflation across emerging markets and further tightening of central bank monetary policies, d) the admission by three separate European sovereigns of their inability to pay back their debt, and e) S&P warns of a possible future downgrade of the US' AAA rating. And yet, in spite of these destabilizing events, global equity markets have stayed in a fairly tight range, epitomized by the 1250-1330 band in which the S&P 500 has hovered in all year.”

Which highlights the real quandary for investors at present: risk is being embraced since there are considered few alternatives: cash earns you negative returns after inflation, bond and commodity markets look equally overvalued.

The one clear trend has been that of the weakness of the US Dollar, notwithstanding the fact that it's impossible to say with any conviction that the other major currency choices look any more (or less) compelling.

In many respects, there is clear evidence of an inverse relationship between the USD and stockmarkets, which may be exaggerated by a carry trade: borrowing in USD's to invest in other currencies merely exacerbates the downward pressure on the USD. We have been concerned about a USD bounce for some months now - we've been wrong on that one (obviously) - but this remains the clear flag to look for as a signal of a turnaround in stock, bond and commodity markets. A USD bounce would reflect a return in interest rate tightening expectations, thereby reversing the Fed's current stance of allowing the USD to take the pressure from prevailing low interest rates (which seem likely to remain a fact of life well into next year).

As the Fed's latest round of easy liquidity (QE2) ends at the end of next month, it will be interesting to see what impact this has on sentiment and interest rate expectations. There is little doubt that the Fed would find pushing through a new round of easy liquidity difficult in the context of a changed Washingtonian political environment, so, for the time being, one assumes that there is going to be no new launch of the QE2's sister ship, QE3. Of course this will depend on the US economy continuing to recover, however slowly, and unemployment continuing to decline.

Back to Damian's point, then: with core markets in the US and Asia within 15% of their all time highs (notably, the Korean market is now 7% above its previous all time high, which itself accounts for much of the outperformance of the pan-Asian and EM indices), how much further can we expect this liquidity fueled rally to continue?

The answer is for as long as liquidity remains easy.

In Asia, where rates have been tightening steadily in markets such as China and India, the impact of tightening has already extracted a toll on their respective markets: the Bombay index is down 7.4% YTD, whilst although the Shanghai index is marginally up for the year, it is still substantially below its all time high of 2008.

So the turnaround seems likely to be flagged by a stronger USD and weaker commodity prices since these will seemingly predict the start of a rise in US interest rates. Watche them carefully. However, since there's not much sign of that happening any time soon, though, we continue to hang on with our fingernails.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, www.roomtoread.org and the Singapore Children's Cancer Foundation www.ccf.org.sg.

The Japanese Earthquake – One week on...

2011-03-17T20:27:00.000-07:00

A week has now passed since Japan was hit by the tragic earthquake and subsequent tsunamis, and we’ve all been watching the commentary with equal measures of horror and sympathy for those affected.

Meanwhile with the clean-up operations are ongoing, financial markets continue to assess the impact on the Japanese and global economies in both the short and long terms.

· Damage to the infrastructure – power and roads – may delay the reconstruction process, but the knee-jerk post-quake sell-off seems to have run its course.

· Expect a short term rebound in equity markets, particularly if no further bad news on the nuclear front emerges.

· But keep an eye on the Middle East.

The volatility of these markets over the past week is in itself testament to the total lack of consensus. After plunging 16% in the first two days, short covering and hope that the worst of the crisis was over resulted in the Nikkei-225 Index rebounding 5.7% on Wednesday before sinking again on Thursday as worries grew over the possibility of a major nuclear catastrophe at the damaged Fukushima nuclear power plant.

While the Nikkei was plunging, the yen was heading in the opposite direction. During the week the yen rose over 5%, hitting a post WW2 high vs. the US dollar. This was widely attributed to Japanese institutions, including insurers liquidating their overseas positions and repatriating the proceeds. However, there is anecdotal evidence that hedge funds, anticipating just such an eventuality, have played an equal part in pushing the yen higher. However, concerted central bank and G-7 intervention on Friday has seen much of these gains reversed, possibly at the unlamented expense of said hedge funds.

The volatility has not been limited to Japan-related assets. Equity markets globally have sold off to varying degrees. The S&P 500 fell 3.6% through Thursday and European markets were off by rather more. Ironically, Asian and emerging markets fared a little better, down on average 1-2%. Korea (which also happens to be one of the largest components of the MSCI Emerging Markets Index) actually rose during the week as that country’s industrial base was seen to benefit from the disruptions to production in Japan.

Oil prices fell on expectations that demand from Japan would decline (although they subsequently rebounded as investors refocused on the still worrying situation in the Middle East). Slightly counter-intuitively, gold (the ultimate hedge assets) also fell slightly, albeit from a lofty position. Again, hedge funds are suspects.

Much of the movements of the last week have been knee-jerk, and not based in any meaningful manner on the real impact on the economy or businesses. There will be winners and losers to emerge from the tragedy. Into the former category will fall construction companies and developers, while insurers and manufacturers with facilities in the earthquake affected region will undoubtedly be in the latter.

The nuclear accident has greatly added to the confusion. Tune in to any of the 24-hour news stations and you will hear yet another instant “expert” expounding on the likely outcome – whether it be minor inconvenience or Armageddon. The only conclusion to be drawn is that nobody, and this would appear to include the operators of the facility itself, and the Japanese government, has much of an idea.

We shall not add to the general level of noise on this subject except to observe that it is this lack of information, exacerbated by warnings from governments of other countries for their nationals to leave, that continues to weigh on markets.

That said, and provided that the nuclear situation does not take another dramatic turn for the worse, we would expect rationality to return to markets and there are signs that this is beginning to happen. As we have said before, Japan is a generally underheld market by foreign investors. Many are weighting on the sidelines for signs of stability. When this returns, a sharp rebound will follow, with commensurate knock-on effects elsewhere.

This earthquake has pushed the other major geopolitical news of the moment, the uprisings in the Middle East, off the front pages. Again, it is close to impossible to know how the situation will resolve itself. Embattled Libyan leader Colonel Gaddafi seems to be close to recapturing his country, but the recent UN Security Council resolution authorising the robust imposition of a no-fly zone may yet change this dynamic, possibly leading to further instability. Meanwhile, the unrest in Bahrain rumbles on and the introduction of troops from foreign countries cannot be viewed entirely positively.

Since the start of the month, global equity markets have fallen over 5%. However, a combination of an underweight position in Japan and a diversified asset base has seen our client portfolios fall by a lesser 1-3% or so (to Thursday’s close). Part of these losses will have been clawed back by the any additional rally in equity markets.

There are three options open to investors at present:

(1) Sell,

(2) Buy,

(3) Sit tight.

On the first, the only reason to lighten up in the current circumstances is if there is a likelihood of re-entry at substantially lower levels. Except in the worst possible scenario, we think that this will be difficult, whilst timing the entry correctly will be an almost impossible act of divination.

On the second, it is clear that some markets have been hit hard, with Japan (obviously leading the way). There is good value to be had there, although given the rapidly fluctuating news cycle this is a tactic to be adopted by only those who are happy to look to the long term and who are therefore able to stomach the shorter-term volatility.

For most of us, therefore, the default advice will be to sit tight for now and wait for further clarity to emerge: we may miss the early snap back on any good news, but at the same time we won’t get our heads bitten off on any lurch downwards.

If you wish to obtain an updated valuation of your portfolio, please contact us and we would be happy to provide one.

The Javelin Team
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).

The Japan Earthquake - Effect on markets and investors

2011-03-13T20:23:00.000-07:00

Friday’s shattering earthquake and subsequent tsunami in the Sendai region of north-east Japan has left thousands of dead and an infrastructure in ruins
Repatriation of funds from overseas has led to a sharp rise in the Japanese yen.
Equities have been sold off sharply in early trade as the Nikkei closed 5% lower on Monday morning.
Although industrial output is likely to be disrupted in the short term due to earthquake damage and power outages, this will be restored and demand will grow as reconstruction kicks in
But the badly damaged nuclear power stations and the potential for a major nuclear emergency will act as a drag for days to come.

Three days after it hit, the full tragic details of Friday’s dreadful earthquake and subsequent tsunami in Japan have yet fully to emerge. The death toll, initially thought to be mercifully light is now climbing rapidly with some estimates putting the final tally in the tens of thousands as rescuers finally gain access to some of the towns closest to the earthquakes epicentre, many of which have been almost totally destroyed. Adding to the disaster has been the news that several of the country’s nuclear facilities have been severely damaged and are in danger of leaking (if they have not done so already) radioactive material into the atmosphere with horrific consequences for the surrounding population.

The earthquake struck too late on Friday to impact the Tokyo stockmarket which had already closed. However, the currency strengthened sharply, a function of funds being repatriated and consequently government bond yields fell sharply (i.e. bond prices went up). When the stockmarket opened this morning, it immediately lost 5% as investors sought to reduce their positions.

The press and airwaves are filled with speculation as to the impact of this disaster on the Japanese, and indeed the global, economy. The truth is that nobody knows yet for sure, and will not until a fuller assessment of the damage has been completed.

This is the largest and most devastating earthquake to have hit Japan since modern record-keeping began and was considerably larger that the 1995 Kobe earthquake. However, the area most affected – north-eastern Honshu – is less crucial to the national economy. Some reports have suggested that it contributes less than 2% to total GDP.

However, the effects of the earthquake may be felt nationally if the damage to the country’s nuclear facilities is as bad as feared. Apart form the humanitarian implications, the closure of some of Japan’s nuclear plants, which accounts for some 30% of the total electricity capacity, will impact electricity supplies nationally. There are already reports of rolling blackouts and it is possible that this, as well as damage to industrial facilities in the Sendai region, will lead to a sharp, if short term fall in output.

The flip side is that the amount of long term reconstruction work will be huge. After the 1995 Kobe earthquake, the Government set aside JPY3 trillion (USD36bn at today’s exchange rates) for this purpose and the total damage was estimated at JPY10 trillion). Whatever the sum eventually needed to put the area back on its feet again, substantial investment will be required. In itself this could be positive for a Japanese economy suffering from deflation and a lack of investment.

Reconstruction activity, too, might keep demand high for materials, suggesting that the spike in commodities prices witnessed over the last year or so is far from over and that prices might continue to rise further.

Kobe in 1995 has become the benchmark most observers are using to project what might happen to financial markets. In the immediate aftermath of that earthquake, the Nikkei fell 8% in the first week and over 20% in the following two months at a time when other markets were rising (some of theses market declines could be attributed to the fact that Barings collapsed at the same time, and its positions were forcibly unwound). It took a total of 10 months for those losses to be recouped. However, thanks in part to fiscal measures taken by the Government at the time, overall GDP growth was little affected.

The big drawback according to many observers is the fact that Japan’s fiscal position is already in a more parlous state, with borrowings at record levels, interest rates already zero and an already uncomfortably strong currency. This may restrict the Government’s ability to spend as much as it might wish to help in the recovery process. However, it has already acted to intervene in the money markets with a JPY7 trillion injection of liquidity into money markets.

A further, total unknown is the state of the various nuclear power plants which have been affected by the earthquake. That damage has been significant is evident. Further reports of explosions and possible radiation leaks are doing nothing for confidence, particularly as the newsflow has been at best sporadic and sometimes contradictory. If, heaven forbid, there has been a major meltdown and leak, then the longer term consequences could be dire indeed.

As an equity market, Japan is already underheld by foreign investors, so there will not be a rash of overseas selling. However, emotions are (quite rightly) running high at the moment, and further falls in the Nikkei are inevitable as part of the “risk-off” trade. Given the expectations of an eventual rebound and the obvious emotion behind the current sell-off, we would be disinclined to reduce positions. Indeed, given the underweight position of our clients, we would be more inclined to monitor closely the situation with a view to entering the market to take advantage of an eventual recovery in sentiment as the reconstruction phase gets underway.

Tripoli Trip Up

2011-02-24T19:45:00.000-08:00

One of the toughest jobs in journalism last year must have been that for the writers of "The Economist" magazine's "The World in 2011" edition, which was printed and written at the tail end of 2010.

The entry for Egypt reads "The presidential election is a contest between continuity (the long-term but ageing president, Hosni Mubarak, if he runs), dynasty (his son, Gamal, who may run instead) and improbability (victory goes to an opposition candidate...)".

The entry for Libya starts with: "Muammar Qadaffi has held power for 40 years and will certainly complete 41... he has removed all significant threats to his rule."

These entries merely serve to prove that the recent ructions in both countries, and elsewhere around the Middle East, blew up out of seemingly nowhere and were not predicted by anyone (viz. the CIA).

These events therefore come under the heading "exogenous shocks" which have an impact on markets and are rarely foreseen. Time will tell whether or not these ones in Libya and Egypt have a more than short-term effect (falling into the background on the seemingly inevitable departure of the odious madman in Libya), or have an effect which is longer lasting - most likely through a permanently higher oil price, should the country dissolve into civil war, or the Qadaffi faction reassert some form of bloody control.

Even in the depressing case of the latter, though, it should be borne in mind that although Libya produces a high quality and much demanded crude oil, it still only accounts for about 2% of global oil output.

On this issue of these types of "exogenous shocks", I went to a presentation this morning from BlackRock iShares, whose newly installed Chief Strategist was giving us his views on 2011.

In overall terms, these can be summarised as follows:

(1) Favour equity over fixed income,
(2) Tactically favour Developed Markets over Emerging Markets for 2/3rds of this year
(3) Favour corporate fixed income over sovereign
(4) Buy Gold on dips

Downside risks are seen as:

(a) Inflation (demand driven). Key things to watch for in this regard are:

Chinese loan growth (if the government doesn't bring this under control inflationary pressures in China will accelerate),
Indian industrial production (the RBI is seen as being behind the curve in draining excess liquidity from the banking system),
Food prices in emerging markets where food accounts for between 1/3 of the CPI basket (China) and 1/2 (India).

(b) A double dip recession, most likely caused by:

An unexpected "exogenous event" (see Libya), such as a permanent spike up in oil prices. Note that every $10 rise in the average price of oil trims US GDP growth by 0.25%,
Too much austerity too soon (which makes the current deficit cutting plans in the UK an interesting case study). Note that the US consumer currently receives 20% of his/her disposable income from the US government (via social security or pension payments). So a big cut in government discretionary spending would hit these payments, and the consumer, hard. Even the tea partiers might have trouble voting for that one.

BlackRock notes that interest rates will remain low this year in the Developed world since at present, governments do not have to compete with the private sector for capital. Long term rates will only rise when private sector debt demand increases (the latter being a reflection of a stronger economy).

Most interesting, though is BlackRock's view on 2012 and beyond.

The key, in its view, are the bond markets.

At present, given the lack of competition for capital, the US government is able to fund its yawning deficits with little difficulty and no risk premium.

In reality though, BlackRock reckons that the US position looks worse than even the European basket cases of Greece and Ireland. Why? Because in Europe, 40% - 45% of GDP is subject to tax (OK - maybe not in Greece, where payment of tax is seen as an optional extra). In the US, the figure is supposedly less than 20% - with much resistance from voters when this number climbs above 20%.

By comparison therefore, the ratio of government debt to government revenue is approximately 360% in the USA vs. about 320% for Greece, 240% for Ireland and 150% for Italy (making Silvio the model of financial probity).

The fact that the US is currently able to fund its debt in US$, has helped postpone the day of reckoning (and a debt watch down grade by the rating agencies) but BlackRock reckons this will come at some point from 2012 onwards when markets will start demanding much higher bond yields. The necessary reforms to the bloated entitlements of Social Security (starting with an increase in the retirement age), Medicaid and Medicare will only come when a crisis of this type forces politicians of all stripes into a corner from which there is no escape.

The issue of course, on the latter, is when this crisis will occur.

So far, markets have been amazingly sanguine about the US deficit and the US debt. A key indicator on the continuing market tolerance of this, or otherwise, will come in negotiations over the Federal Budget which must be concluded by the end of June this year. Even the tea partiers are wary of causing a government shut-down for being too heavy handed on forcing spending cuts on the three big entitlements - the only places that cuts will make any substantive difference: everything else is so much window dressing.

The implication is therefore, that political courage will only rise to the surface when politicians are faced with the prospect of having to make changes no matter what the political consequences.

At that point, those in power will be turfed out no matter who they are and how secure they might seem in the months before - just ask Messrs. Mubarak, Qadaffi and that bloke in Tunisia...

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).

What's up with Emerging Markets...?

2011-02-17T16:16:00.000-08:00

Since the beginning of 2011, whilst the US market is up 6.3% on the S&P500 and the MSCI World Index up 5.9%, Asia Ex Japan and the Emerging Markets are both down down 3.5%. This relative under performance continues a trend that began in the final quarter of 2010.

Given that the 2011 "consensus" amongst strategists (and ourselves) was in favour of Asia and EM continuing to make strong gains on the back of robust growth, healthy government, corporate and consumer balance sheets, such sluggishness is surprising.

This is, of course, unless you follow the view that "consensus" is merely the moment at which the majority of pundits (including ourselves) have got the call wrong.

Our defence is twofold:

First, we emphasized in the latter part of 2009 and in December last year that it looked as though we were headed for a period in which Developed Markets - DM - (and especially the US) outperformed Asia and Emerging Markets - EM (please see the blog entries for Dec 2009 and 2010 respectively).

In the event, it was not until Q4 2010 that market leadership actually changed (primarily because of the sluggishness of US growth and the periodic bouts of European heart failure up until that point).

Secondly, we also need to emphasize a difference between a 'tactical call' that favours DM over EM (for the first half of 2011) and the longer term 'strategic call' that favours EM over DM (for the whole of the 21st century). It is inevitable that although the longer-term strategic call may be right, in the short-term, we will see periodic bouts of over and undervaluation as markets adjust to short term sentiment and money flows. That's what we're seeing at the moment - the reversal in fund flows to EM and back into DM over the last couple of months has been dramatic.

Ok - that's the self justification over with. I still haven't given an opinion on why there has been this switch away from EM...

To that end, I've found a couple of research pieces which help to illustrate the quandary.

(a) Jim O'Neill, the Goldman economist who coined the phrase for the BRIC's (four completely different economies that had the sole characteristics that they were all big and developing), has said that EM's have been undermined by inflation fears and concerns about the effect of retaliatory interest rate increases and other control measures. However, in Jim's view, inflation "is the obvious thing to start worrying about once [analysts] stop worrying about the risk of depression". Good point: it was only at the beginning of last year that the same analysts were still talking about the greater than evens likelihood of a "double-dip" recession.

(b) A note from Credit Suisse highlighted recent deterioration on the EM indices of industrial production, whilst rising food prices etc. (1/3rd of CPI) means that EM inflation may not peak until mid 2011.

(c) The more obvious point is that the rate of growth is currently accelerating in DM, whilst it is decelerating in EM (from a high base after the double digit gains of 2009 and 2010). On that basis, DM is the rotation trade for the first half of 2011.

So - we have added more US and DM to our model and client portfolios, but remain strategically overweight EM, because this is the region where the money is, and where currencies will continue to see strength as governments look for ever more creative ways to choke off inflationary pressures, short of actually increasing interest rates.

Interestingly enough, we're beginning to mull our position on Japan - a market that we have - we think rightly- ignored as a virtual investment irrelevance for a long time.

The reasons for ignoring it are well worn (political sclerosis, the world's highest level of government debt, an aging and declining population, controls on immigration, resistance to change at the corporate level, a resigned acceptance of genteel decline).

Never the less - and again on a tactical basis - it's the one market in Asia that is a leveraged warrant on US recovery and the one Asian market in which inflationary concerns are zero (some inflation would be viewed as positive after decades of deflation). We have exposure to Japan via our global fund positions, but we're looking to add some at an individual country level.

Finally, on EM, given the fact that we're still long-term bullish, any weakness should be used as a buying opportunity, particularly in China and India which are now trading at discounts in multiple terms to their 5 year averages (India at an 11% discount, and China at 14%). Although India is grappling with inflation and corruption scandals, and China has increased bank reserve ratios, and interest rates several times over the last 6 months in response to inflationary pressures, our view firmly remains that "this too shall pass...".

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).

... and our key points for 2011

2010-12-20T23:04:00.000-08:00

Herewith our 6 of the best for 2011...

(1) In order for the major markets to advance further, corporate revenue (top line) growth needs to be seen to be taking over from cost cutting as a source of real earnings recovery and momentum. Much of the growth up till now has been driven by gains in productivity, as companies make more with the same. This is the reason why unemployment statistics in the US and elsewhere remain stubbornly high. Having said that, recent data look reasonably encouraging and supportive of our decision to add to weightings in the US (but not continental Europe). On that basis, we expect equity markets to continue rising, but at a slower pace, with market leadership being taken by the US on a recovery story basis and less so Asia & EM.

(2) Interest rates will remain low in the developed economies but will be rising steadily in the supposedly "emerging" economies as ongoing efforts are made to restrain inflationary pressures and speculative investment activity. Low real returns on cash and bonds will continue providing equity market support, especially after occasional sharp sell-offs.

(3) Nonetheless, key macro indicators will remain contradictory, with debt workouts suppressing demand in the US and Europe and strong domestic demand growth in Asia and EM.

(4) The demise of the USD is overstated, since in the ongoing Ugly contest between the USD, the EUR, GBP and Yen, all the major currencies look as bad as each other. As we have seen in 2009 / 2010 its all going to be very rotational.

(5) For commodities, we expect a still steady rise, although anticipate that Gold and precious metals will be a lot more volatile at the levels upward. As markets lurch between fears of inflation / deflation , USD demise / recovery, and Global growth / recession, there will be sharp swings which from a trading basis (which we don't do) will provide interesting opportunities. Buy and Holders like us, will hang in there.

(6) The big question mark for 2011 hangs over the bond markets: the odds in favour of some sort of Euro member default (although it won't be called that - maybe a "managed rescheduling"?) have to be pretty high in order to prevent a much more serious political collapse. In the US it won't be the Treasury market that causes trouble, but the much more opaque municipal bond market: the financial health of many individual US states looks every bit as bad as many of the much-loathed peripheral Eurozone members. If you start seeing more evidence of a bond buyers strike the risk of contagion into the more liquid government debt markets get much bigger. At the moment, the wonderfully prescient rating agencies seem to regard the municipal bond mess as "not a problem", until of course it is. Please see http://pragcap.com/the-coming-municipal-bond-crisis for further background...

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).

A review of our "Ten for '10"

2010-11-08T17:59:00.001-08:00

Back at the beginning of March, we made ten predictions for 2010, and I thought it might be interesting to see how these got on:

(1) Interest Rates: "These will remain low - globally". 1 out of 1. The impact of high unemployment and a race for the currency bottom has meant that, outside of a few examples (India, Australia etc.), interest rates have been held down in the interest of trying to encourage a bit of borrowing and investing. Not much success there, unless you count the consequential impact of hot money flows into Asian and the EM's
(2) Bond Yields: We raised the risk of a "bond buyers strike" arising from problems on the periphery causing bond buyers to demand higher yields overall. Whilst it's true that the PIIGS saw yields spike up massively in June in the face of the Greek crisis, the impact on bond yields elsewhere was limited as investors fled to the greater perceived security of the Fed, Bundesbank and BoJ. In the UK, the noises made by the UK government on budget cuts were well received and bond yields eased off. We'll score a half: 1 1/2 out of 2.
(3) Stockmarkets - Positive, although we suspected that leadership would move to developed markets as opposed to EM and Asia. We were right on the direction, wrong on the mix. Another 1/2: 2 out of 3.
(4) More bank capital raisings - Yes. Standard Chartered, a bunch of banks in Europe & Japan, though none of the majors in the USA. 3 out of 4.
(5) USD to surprise on the upside - Big no. The USD index was at 80.48 in March and is now at 77, whilst against the Yen it has gone from 90.38 to 81.18. Blame more QE for the slump, but we got it wrong. 3 out 0f 5.
(6) SGD to strengthen to 1.35. Back in March the SGD was standing at 1.3991. It's now at 1.2879. Although we got the direction right, we've been surprised by how far the MAS has allowed the currency to run up against a supposedly firm target range, so we won't score more than 1/2 on this one. 3 1/2 out of 6.
(7) Commodity prices - A gradual recovery was expected although with Gold rising to $1,300 (in March it was $1,125). It's now at just under $1,400, but we'll give ourselves that one. 4 1/2 out of 7.

So those were the main ones, on which we scored 64%, and I give my kids a hard time if they don't get 85%....!

Since you must ask, the other ones were:

(8) US politics: "Democrats to do better than expected in the mid terms on the basis that no-one could possibly vote for the nutty conservative right" (subsequently named the Tea Party). Umm, No. The Dems have hardly covered themselves with glory, but whoever said that common sense and democracy were good bed fellows? Winston Churchill's aphorisms that "the best argument against democracy is a 5 minute conversation with the average voter", and that "democracy is the worst from of government, except for all the others that have been tried from time to time" seem fairly apt here.
(9) UK politics - Conservatives to win with a narrow majority. Sort of, but only with the help of the Lib Dems. Sandals now mandatory in Cabinet meetings (plus socks).
(10) World Cup - Since Scotland had graciously removed itself from the competition in the qualifying rounds to give the other teams a shot, we predicted that England would obviously win since they had some highly motivated, experienced, cohesive team players. Trouble is, those guys were actually playing for Spain, and England had Wayne Rooney. Phew.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).

On tenterhooks....

2010-11-03T19:24:00.000-07:00

So -

Now we have the Fed announcing that it will slosh another $600bn in the direction of the bond markets, in attempt to get the economy going in whatever fashion possible by just using artificially created money.

As a skeptical US economist said on the radio this morning, yet more QE seems unlikely to result in a rebound unless it also helps to boost overall levels of consumer and business confidence, and that's what it all comes down to: confidence.

Sure, it seems cheap to borrow in the US (if the bank will lend you the money), but if you're worried about your job, or if you fret that the demand won't be there for the products your new machine will produce, you may just opt to postpone that spending decision until such time you feel more secure that your spending decision is justifiable.

We can see that this is a circular argument, without confidence, consumers don't spend and companies don't invest, thereby creating the confidence needed to encourage spending in the first place.... and so it goes on.

Obviously QE, by itself, is not going to do that simply by keeping interest rates at levels below where they would otherwise be.

Maybe more government spending would help, by taking up some slack in capacity? Unfortunately, the last lump of stimulus spending seemed largely to have run into the sand (or the benefits from it were obscured by declines in private sector spending elsewhere). Because of this seemingly indifferent precedent, the rabid anti-spending Tea Partiers have plenty of ammunition to boost their post US mid-term attack on government spending. So much so that the previously open cheque book will now be nailed shut. The implication could also be that the US government is likely heading for a bout of the austerity that the Europeans (well some of them) have already signed up to, and to which so many liberal economists like Paul Krugman are vehemently opposed.

On a more positive note however, many businesses claim to have been delaying spending decisions until such time as tax policies become clearer, and the Republican ascendancy has certainly made that position more obvious: the Bush tax cuts seem likely to be renewed whilst being balanced by some government spending cuts. Not much of an impact on the size of the deficit, but short-term reasonably positive for markets.

For 2011 therefore, it looks as though the US economy and its markets will continue to "muddle through" in the absence of a magic bullet that encourages consumers and business to start spending and investing again.

For the rest of the world, and Asia and Emerging Markets in particular, the outlook is much more positive if only because, as we noted last month, low US interest rates are contributing to the ongoing growth in an inflationary bubble and significant hot money inflows.

We all know it'll probably end badly, but the big question is when. There's plenty of evidence to suggest that they are just getting started, and Emerging Markets have shown many times in the past that they can run way above valuations that seem fully justifiable. In the absence of any other alternatives for investors (returns on cash and bonds look even less attractive), this picture could be a main feature for much of 2011.

We remain fully invested in our usual diversified mixture of equity, bond, commodity and alternative funds, but, if a "tenterhook" is "one of the hooks or bent nails that hold cloth stretched on a tenter"...then we've got them dug in all over the place.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).

"Pushing on a piece of string"

2010-10-07T18:37:00.000-07:00

We've been reading a lot recently about the shortcomings of the Quantitative Easing (QE) process, with the argument being that it makes no difference how low rates go and how much money Central Banks print: if commercial banks aren't lending it out, then the "money multiplier" fails to kick in, businesses don't borrow to invest and housing markets and the consumer remain flat on their backs.

There has been a lot written about why banks aren't lending all this cash they are collecting and it seems to distill down to two main reasons. Firstly that they are using their currently wide interest margins to assist in the balance sheet repair process, and until that process has been completed, they are reluctant to take on new credit risk of any kind.

Secondly, like a duck, whilst things may look serene on the surface: underneath they are paddling hard against the current: in this case the current is provided by fears of another wave home foreclosures. If you want to see this grim prediction in all its glory, go to:
http://pragcap.com/chris-whalen-describes-why-2011-could-make-2008-look-like-a-cakewalk
in which a commentator suggests that less than 25% of all likely foreclosures have so far been resolved. Cheery stuff.

All this points to the fact that interest rates aren't moving anywhere any time soon.

The more sluggish the economy, and the more intractable the unemployment numbers, the less the likelihood of any inflationary pressures building that would warrant an interest rate increase. Under this scenario, the "output gap" will be a structural issue for some time to come as the US economy continues to crawl along below its optimum.

However, drag your eyes away from the US and the "developed" markets for a while and look at Asia and the emerging markets: domestic demand is rising here and inflation is picking up. Yet, with many countries effectively importing monetary policy from the US, along with its low interest rates, the cost of borrowing is substantially lower than it probably should be.

A quick check with a local bank here in Singapore suggests that you can borrow to fund the purchase of a yet to be completed residential property project for the floating rate of 1.1%, with a 70% loan to value ratio. The cost of that loan looks ridiculously low, but with the MAS unlikely to take steps to increase rates any time soon as a consequence of the SGD recently breaking through $1.32 to the USD (it started the year at $1.4054), these conditions seem likely to continue for a while.

Is this a bubble?

It certainly feels like one with residential property prices up nearly 4x since their post Asian crisis lows of 10 years ago. However, it also feels as though this could continue inflating for a while, particularly if the US does no worse than continue on its current pattern of anemic growth (if we were to see a "double-dip" recession coming through at some point, all bets are off).

In addition, don't forget that the artful (or maybe that should be artificial?) loan syndication that ultimately led to the 2008 property crash in the US and Europe has not happened in Asia and seems unlikely to happen under the supervision of regional central banks who only recently stopped licking the wounds caused by the Asian financial crisis of 1998.

So, although QE in the US, Europe and Japan may be having a limited impact there, the upshot is that it is having a very big impact in Asia and the Emerging Markets. The easy money that was supposed to go to the US, European or Japanese consumer or small business is, instead, being grabbed by their emerging markets' counterpart, who has plenty of uses on his or her own doorstep for the credit being offered.

As I say, if we get a double-dip recession riding back into the US, then Asian confidence will take a short-term hit - as it always does (no emotional de-coupling here), before the liquidity taps are turned on full.

But, if we continue to see no worse than sluggish growth in the US, Europe and Japan in 2011, the Asian and Emerging Market balloon looks as though it could carry the basket a lot higher....

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
Javelin Wealth Management supports www.kiva.org, the global microfinance philanthropy initiative, and the Central Asia Institute (see www.ikat.org).