January 23, 2010

Market Insights - 23 January 2010

Dear Friends & Fellow Investors

Here  is the latest issue of Market Insights. As always, please email any questions to: . 

In This Week's Issue
• Weekly Snapshot
• Chart Of The Week
• More On China 
• Global Economic Prospects 
• Recommended Read & Video 
• MBA Reality Check

Weekly Snapshot
• Goldman Sachs 2009 net income surged to $13.4bn (FT)
• Industrial new orders up by 1.6% in Euro area (Eurostat)
• Obama calls for new restrictions on size and scope of big banks a.k.a. "Volcker Rule" (WSJ)
• World Bank expects Global GDP to grow 2.7% this year and 3.2% in 2011 (World Bank)
• Euro under pressure as markets fear wider impact of Greek crisis on Euro area (Eurointelligence)
• US building permits in December 2009 were 653,000, an increase of 10.9% from November (ESA)
• US Producer Price Index moved up 0.2% in December, seasonally adjusted (BLS)
• US Housing starts in December fell back 4.0% after rebounding 10.7% in November (Bloomberg)
• China orders its banks to temporarily halt lending to slow credit growth (FT)
• Russia's Central Bank started buying Canadian Dollars to diversify its Forex reserves (FT)
• China grew 10.7% y/y in Q4 of 2009, accelerating from a 9.1% y/y growth rate Q3 (Economy.com)
• US Leading Economic Index (LEI) increased 1.1% percent in December (Conference Board)
• Sugar price reaches 29 year high at 29 cents per pound (FT)
• Bank of Canada leaves rates at a record low 0.25%, scales back money market operations (Reuters)

Chart Of The Week 
A reminder of how US creditors changed during the decade (Click on chart for larger image).


* Caribbean Banking Centers include Bahamas, Bermuda, Cayman Islands, Netherlands Antilles and Panama (BVI since 2006).
** Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.

More on China 
China continues to make news these days.  Unabated economic growth has put the country at the forefront of global economic power players.  It is now back to double-digit growth barely a year after the worst recession since the Great Depression hit all major financial markets and economies. But despite economic progress, China also continues to mystify foreigners, in particular foreign investors. Personally, I claim no knowledge of understanding Chinese politics, its society and its people nor would I be in a position to advise on the merits of investing in China.  Yet, with growth rates at about 10% and a re-ignited property boom, one could easily be tempted into investing - perhaps a Chinese focused Mutual Fund or ETF? But let us take a step back first...

Investing in China, whether directly or via one of the many investment vehicles, comes with a long list of caveats.  Even the big multi-nationals (most recently Google) could sing a litany of songs about corruption, red-tape, cultural and language issues, all of which can weigh heavily on investment returns. And how about all the fabulous stories of growth, exuberance and unheard-of property prices? 

I find it tough enough to trust the official economic numbers of the US or the European Union, how much more must one question official data from a command economy like China. So let's forget about everything that China says and focus on a few things they have done and continue to do as we speak.  I will use a few charts to help illustrate some important milestones....

As late as 1981, China started to actively massage its exchange rate versus the US$ with a clear long-term objective:  To devalue the Renminbi to gain a massive competitive pricing advantage for their exports. In 1981, when the US and Europe were united in fear that Japan would be the dominant global economic powerhouse, the Renminbi was trading around 1.5 versus the US Dollar.  In subsequent years, the currency was allowed to depreciate allowing the USD/CNY rate to reach up to 8.7 Yuan per US Dollar. A few years back, when the then US Treasury Secretary Paulson argued that the Chinese currency was about 40% undervalued, it was quite an understatement in historic perspective.


From a macro perspective, the exchange rate movements of the Renminbi are in stark contrast with those of Japan and Germany, two similarly export-driven economies that saw their country rise from economic insignificance after WWII to major export nations by the 1970s and 80s.  As their economies grew, so did their exchange rate gain in value against the US$, particularly after the Bretton-Woods agreement was abandoned and currencies were allowed to freely float in the early 70's. The example of the Japanese Yen clearly shows how the Japanese Yen gained about three times the value against the US$ just before Japanese Equities reached their all-time high in 1990. 


China, by contrast, embarked on an export-driven model with a simple principle:  produce as much as possible and sell it as cheap as possible.  Aided by the 8:1 pricing advantage achieved between 1980 and the mid-90s, China was able to undercut all competing countries while still retaining massive profit margins.  The downside to this policy however was rampant domestic inflation. Exporting goods at unrealistically low exchange rates means one has to import everything else (e.g. raw materials for goods of production) at much higher prices. With the credit crisis in 2008, those inflation fears came to a halt when the world's asset prices united in a deleveraging process across all asset classes.

But with massive stimulus from the Chinese government using ultra-loose monetary policy, China quickly regained all losses from 2008. (Ed. Note: A big plus of a command economy over a democratic, semi-free market economy is quite simply that things can get done very fast.  When China orders its banks to lend, they do lend)  Net result: an economy so hot that a number of Chinese Banks were now ordered to stop lending, at least until the end of the month. 

Liu Mingkang, head of the China Banking Regulatory Commission (CBRC), said in an interview Jan. 20 that several Chinese banks had been asked to restrain their lending after proving to have inadequate capital reserves. Chinese media reports claimed that new bank loans so far in January have risen to as high as 1 and 1.5 trillion yuan ($146-$220 billion) — approaching or equaling the massive hike in January 2009. As a result, several major Chinese commercial banks (whose names were not given) were given oral commands to stop new lending for the rest of the month.

As far as China is concerned, inflation is definitely back on and along with that, renewed speculation about the revaluation of its currency.  Whether China will let its currency appreciate or not is no longer the question but rather when it will do so.  That of course is the Million Dollar question and I wish I had an answer. While I cannot foresee when this will happen, there are some additional signs that China is preparing for a second phase of gradual or managed currency revaluation: 

An early sign came last year when Brazil and China agreed to use their own currencies in trade rather than settling their dues in US$.  A further sign was the fact that the Bank of China, as well as some other Central Banks started to convert more of their foreign currency holdings into a basket of currencies including Euro, Swiss Franc and Japanese Yen.  However, a development that went somewhat under the radar was the fact that China stopped buying US treasuries by the middle of last year.  As the chart below shows, China has embarked on a decade long buying spree of US Treasuries increasing their holdings from about $71Bn in 2000 to over $800bn in May 2009.  Since last summer however, no net purchase were added, instead their holding decreased by over $10bn since. This may indicate a trend of further divesting of US treasuries.


Going back to the prospects for the CNY versus US$, it has been at the same level of about 6.8 since July 2008, barely moving an inch in either direction.  It may very well stay there for an extended period of time. However, all other things being equal, the currency revaluation might just be the right valve to keep Chinese domestic inflation under control.  Lastly, in case you were not aware of this, the Chicago Mercantile Exchange (CME) has recently started offering Chinese Renminbi Futures and Options.  There is of course also an ETN (CNY) allowing you to express your opinion on the future of this currency with your wallet.  But please be aware of potential risks of trading these instruments - they are not for the novice investor.  If you like more info on these instruments or any other currency products, please email me.

Global Economic Prospects
The World just published its annual report on Global Economic Prospects 2010: Crisis, Finance, and Growth.  The complete report can be downloaded here.

Based on the report findings, the worst is behind us and the world economy should get back on its feet with average growth rates of 2.7% (2010) and 3.2% (2011). But despite its volume (some 180 pages) and in-depth coverage of various possible scenarios affecting all countries, one has to wonder about some of the assumptions made in a rather positive assessment of world economic growth going forward. Running the risk of over-simplifying, I do wonder why there is not a single region expected to experience economic contraction, even under a deeper recession scenario. Curious...

WB Forecast

Recommended Read
Please consider David Altig’s Blog post:  It's jobs, not discouraged workers
One might not agree with Mr. Altig’s assumption that some 500,000 discouraged workers might come back to the labor pool now causing additional competition among the unemployed.  What is perhaps more concerning is the fact that this pool of discouraged workers seems to be expanding. 

Chart: Courtesy of http://macroblog.typepad.com/macroblog/

Recommended Video 
Never shy to cause some raised eyebrows, James Altucher has done it again when he says the 'American Dream' Is a "Scam".  He notes that most people neglect to factor in the substantial (hidden) cost of owning a home when considering housing as a pure investment. Please consider this interesting interview:

MBA Reality Check
Harvard Business Review just published: The Best-Performing CEOs in the World
Very interesting to see who is on that list and even more interesting to learn what their backgrounds are.  As a Business School graduate, I often wonder about the merits of an MBA degree, considering the time, effort and substantial capital that went into the education.  Going through the list of  Top50 CEOs, I noticed that only 15 out of 50 (less than a third) had a formal business education.  Although I still consider business school one of the best investments I ever made, one has to wonder what these Non-MBAs know that isn’t taught in business school and whether or not that skill can be taught at all?

Next time you consider an investment, you may wonder what makes people like Steve Jobs such an “out of the box” thinker; perhaps the same thought process could be used when analyzing your next investment.

On that note, good luck and good trading!

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

1 comment:

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