China Cuts First-Round Rare Earth Export Quotas by 11%
By Bloomberg News - Dec 28, 2010 11:37 PM GMT+0800
Play VideoOct. 28 (Bloomberg) -- Mark A. Smith, president and chief executive officer of Molycorp Inc., owner of the world’s largest non-Chinese deposit of rare-earth metals, talks about demand for the minerals. Rare-earth prices have jumped after China, the source of more than 90 percent of worldwide supplies, cut its second-half export quota. Smith speaks from Denver, Colorado, with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
China cut its export quotas for rare earths by 11 percent in the first round of permits for 2011, threatening to extend a global shortage of the minerals needed for smartphones, hybrid cars and guided missiles.
The government allotted 14,446 metric tons of rare earth exports split among 31 companies, the Ministry of Commerce said today in a statement. That compares with the first round this year of 16,304 tons and the second round of 7,976 tons, according to previous ministry statements. The government usually issues two rounds of export quotas every year.
China, which accounts for more than 90 percent of world supplies, slashed export quotas by 72 percent in the second half of this year, sparking a surge in prices. Japan, the world’s biggest user, has sought alternate supplies with companies including Hitachi Metals Ltd. and Toyota Motor Corp. seeking cooperative ventures at home and abroad to secure the minerals.
“This is in line with government officials’ comments that we need to protect the environment and resources,” said Chen Jiazuo, an analyst at metal researcher Beijing Antaike Information Development Co. “Controlling domestic production capacity, output and exports will continue to be the theme.”
Chinese government departments are still negotiating full- year rare earth export quotas for 2011, the ministry said in a separate statement today. Full-year permits should not be forecast based on the first-round limits announced earlier, according to the statement.
Industry ‘Sustainability’
The government will decide on the full-year quotas after evaluating domestic output and demand, as well as global requirements, the ministry said. The “sustainability” of the industry in China also will be reviewed, according to the statement.
Last year, China’s government clamped down on its rare earth industry, setting production quotas to bolster prices. China said in July that it would reduce export quotas in the second half to supply its own electronics industry and overhaul a mining sector blamed for causing widespread environmental damage.
“As China has advanced technologies in rare earth production, companies can seek cooperation to develop mines abroad,” Antaike’s Chen said.
China will also raise export taxes for some rare earth elements to 25 percent next year, the Ministry of Finance said this month. That was up from the 15 percent temporary export tax on neodymium, used in batteries for hybrid cars including Toyota’s Prius and Honda Motor Co.’s Insight.
U.S. Tensions
The latest move to curb exports may further exacerbate tensions with the U.S., which last week said it may file a World Trade Organization complaint over restraints on supplies of the minerals. Rare earths are 17 chemically similar elements including neodymium, cerium and lanthanum that are used in the production of electronics.
Molycorp Inc., the owner of the world’s largest non-Chinese rare-earth metals deposit, agreed this month to form joint ventures with Japan’s Hitachi Metals Ltd. to produce alloys and magnets in the U.S. Hitachi Metals, Japan’s largest maker of rare-earths magnets, uses as much as 600 tons of the metals each year.
Shares of Molycorp rose $2.85, or 5.8 percent, to $52.29 at 10:33 a.m. in New York Stock Exchange composite trading. Rare Element Resources Ltd., a Vancouver-based rare-earth miner, jumped $2.29, or 20 percent, to $14.02 in New York. General Moly Inc., which is developing a molybdenum mine in Nevada, climbed 42 cents, or 7.1 percent, to $6.32.
Toyota Venture
Toyota Tsusho Corp., a trading company affiliated with the carmaker, formed a venture with Sojitz Corp. and a Vietnamese state-run mining company to export rare earth metals to Japan from 2012, spokesman Katsutoshi Yokoi said in September.
Toyota spokeswoman Shiori Hashimoto declined to comment on China’s latest move today, saying the company already was exploring alternative sources of rare earth.
The price of neodymium oxide, used in magnets in BlackBerrys, has surged more than fourfold to $88.5 a kilogram from $19.12 in 2009 because of rising demand and reduced supply from China, according to Sydney-based Lynas Corp., which is building a A$550 million ($542 million) rare earths mine in Western Australia.
Demand growth for neodymium and dysprosium may be 15 to 20 percent per annum, Damien Krebs, a metallurgy manager at Australia’s Greenland Minerals and Energy Ltd., said in an interview on Nov. 10. Neodymium is also used in mini hard drives in laptops and headphones in Apple’s iPod.
‘Guide’ Industry
China is close to establishing an association that will work under government oversight to “guide” the domestic rare earths industry, Wang Caifeng, a member of the committee overseeing the group’s formation, said at a conference in Beijing today.
The China Association for Rare Earth will be organized under the authority of the Ministry of Industry and Information Technology and include the biggest 93 domestic producers of the minerals, Wang said.
Output and export of rare earths from China have been reduced because some of the companies mining the minerals were causing “severe” environmental damage and had to be closed, Wang said.
“Excessive mining in southern provinces is still severe and it severely damages the environment. That’s why China is controlling mining, and naturally output and export will be reduced,” Wang said.
To contact the Bloomberg News staff on this story: Helen Sun in Shanghai at hsun30@bloomberg.net
To contact the editors responsible for this story: Richard Dobson at rdobson4@bloomberg.net; Patrick McKiernan at pmckiernan@bloomberg.net.
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Wednesday, 29 December 2010
Tuesday, 28 December 2010
Living in a Temperate Climate is Far Superior Than the Tropics
I love Singapore. I love my family, friends etc. But Singapore has 2 BIG LETDOWNS.
First, it is very hot and humid, like a sauna. I constantly find myself getting away to cold countries during the winter to soak up the cold before returning. I lived in New Zealand, south island and I loved the cold. It was constantly below zero during winter and in the summer, it is dry and hits around 30 degrees noon time but dips to 16 degrees at night. It's nice. Your complexion improves, you don't get pimples, and you feel like walking, hiking, running because you don't face the piercing sun that damages your skin and you don't have that energy sapping heat.
Second, it is too small. I can't get away to the country side over the weekends without going through the uncertainty of a big jam at the causeway. A jam can easily burn 2 - 3 hours out of my precious weekend. Worse, JB is not safe. I almost got car jacked once, got threatened by a thug twice who then scratched my car. Worst of all, I got stopped by the police more than 5 times wanting to fine me but yet refusing to issue me a ticket.
In a cold climate, you can dress up in a nice coat, wear a turtle neck, wear nice boots without sweating like a pig. Ladies can put on more makeup without fearing it running. I could down a bottle of sake and feel the internal heat while walking outside.
It was around -1 degrees in Kyoto at night, around 4 degrees in Osaka and was 7 degrees in Tokyo. I love every minute of it.
This is Shabu Shabu in Kyoto. You can down it with sake and you'd still feel alright walking in the -1 degree cold! People in cold climates tend to be taller and have sharper, longer noses. It's evolutionary because you need a long, narrow nose to moisten and warm the air going into your lungs... So come join me in a cold climate... migrate there!
First, it is very hot and humid, like a sauna. I constantly find myself getting away to cold countries during the winter to soak up the cold before returning. I lived in New Zealand, south island and I loved the cold. It was constantly below zero during winter and in the summer, it is dry and hits around 30 degrees noon time but dips to 16 degrees at night. It's nice. Your complexion improves, you don't get pimples, and you feel like walking, hiking, running because you don't face the piercing sun that damages your skin and you don't have that energy sapping heat.
Second, it is too small. I can't get away to the country side over the weekends without going through the uncertainty of a big jam at the causeway. A jam can easily burn 2 - 3 hours out of my precious weekend. Worse, JB is not safe. I almost got car jacked once, got threatened by a thug twice who then scratched my car. Worst of all, I got stopped by the police more than 5 times wanting to fine me but yet refusing to issue me a ticket.
In a cold climate, you can dress up in a nice coat, wear a turtle neck, wear nice boots without sweating like a pig. Ladies can put on more makeup without fearing it running. I could down a bottle of sake and feel the internal heat while walking outside.
It was around -1 degrees in Kyoto at night, around 4 degrees in Osaka and was 7 degrees in Tokyo. I love every minute of it.
Saturday, 25 December 2010
Emerging Equity Funds Post First Outflows Since May
Emerging Equity Funds Post First Outflows Since May
By Jonathan Burgos - Dec 24, 2010 12:28 PM GMT+0800
Emerging-market equity funds posted the first net withdrawals since May in the week ended Dec. 22 amid concern China will continue tightening monetary policy, trimming a record-setting year for inflows, EPFR Global said.
For the year, emerging-market stock funds have taken in a record $92.5 billion and bond funds investing in developing economies had inflows of $52.5 billion, nearly seven times their previous annual inflows on record.
"Uncertainty about inflationary trends, investors’ fear of being caught up on the wrong side of capital controls and basic profit-taking kept the pressure on EPFR Global-tracked emerging markets funds going into the final week of 2010,” the Massachusetts-based research firm in an e-mailed statement.
China’s central bank raised bank reserve requirements on Dec. 10 for the third time in five weeks as inflation quickened to its fastest pace in 28 months in November. Home prices in 70 Chinese cities climbed 7.7 percent in November from a year earlier, even after the government raised borrowing costs for the first time in three years, suspended mortgages for third- home purchases and pledged to introduce a property tax.
The Shanghai Composite Index fell 0.5 percent as of 11:30 a.m. local time, on course for a 1.8 percent weekly retreat. The measure has lost 13 percent this year, making China the worst- performer among Asian stock markets, according to data tracked by Bloomberg. The MSCI Emerging Markets Index, tracking 21 developing nations, sank 0.2 percent, snapping a three-day gain.
Stock funds overall took in $4.5 billion during the week, while bond funds had net redemptions of $2.3 billion, according to the research company.
By Jonathan Burgos - Dec 24, 2010 12:28 PM GMT+0800
Emerging-market equity funds posted the first net withdrawals since May in the week ended Dec. 22 amid concern China will continue tightening monetary policy, trimming a record-setting year for inflows, EPFR Global said.
For the year, emerging-market stock funds have taken in a record $92.5 billion and bond funds investing in developing economies had inflows of $52.5 billion, nearly seven times their previous annual inflows on record.
"Uncertainty about inflationary trends, investors’ fear of being caught up on the wrong side of capital controls and basic profit-taking kept the pressure on EPFR Global-tracked emerging markets funds going into the final week of 2010,” the Massachusetts-based research firm in an e-mailed statement.
China’s central bank raised bank reserve requirements on Dec. 10 for the third time in five weeks as inflation quickened to its fastest pace in 28 months in November. Home prices in 70 Chinese cities climbed 7.7 percent in November from a year earlier, even after the government raised borrowing costs for the first time in three years, suspended mortgages for third- home purchases and pledged to introduce a property tax.
The Shanghai Composite Index fell 0.5 percent as of 11:30 a.m. local time, on course for a 1.8 percent weekly retreat. The measure has lost 13 percent this year, making China the worst- performer among Asian stock markets, according to data tracked by Bloomberg. The MSCI Emerging Markets Index, tracking 21 developing nations, sank 0.2 percent, snapping a three-day gain.
Stock funds overall took in $4.5 billion during the week, while bond funds had net redemptions of $2.3 billion, according to the research company.
Friday, 24 December 2010
What Bubble? Commodities Have More Upside in 2011
by: Wall St. Cheat Sheet December 21, 2010
By Jordan Roy-Byrne
Even though Commodities as per the CCI are within 2% of an all-time high (and at an all-time high when priced against a basket of foreign currencies), there is absolutely no sign of a bubble or froth in the commodity complex. Various data will show that both Commodities and the commodity stocks are under-owned and have more room to rise.
One way to measure the value of a sector is to look at a sector’s overall size as a percentage of the S&P 500 (NYSE: SPY). The chart below is from Ryan Puplava of PFS Group. It is a bit dated, but as of today Energy and Materials comprise 15% of the S&P 500. The 2008 peak was about 19%. The 1980 peak was 43% while Technology peaked at 35% in 2000 and Financials and Consumer Discretionary accounted for 35% of the S&P 500 in 2005.
In addition, some sentiment indicators show there is little interest in Commodities. Assets in the Rydex Commodities fund (c/o of Sentimentrader) were over $300 million at the 2008 peak and dwindled to as low as $40 million. The CCI has recovered to near an all-time high and even the CRB is at a two-year high, yet assets in the fund are only $43 million! Moreover, we can clearly see what happens in a bubble as in 2008, assets surged about 300% in six months.
Also from Sentimentrader, we see 59% surveyed as bullish on Commodities. While this is a two-year high, it is well below the levels of 2006-2008.
Despite the solid performance of the commodity sector, investors don’t seem to be enthusiastic. For one, the stocks comprise 15% of the S&P 500 compared to 19% in 2008. Perhaps investors don’t want to get burned again as in 2008? Perhaps they like the safety of bonds more (which fund flows do indicate)?
In any event, contrary analysis tells us that skepticism, a wall of worry or outright indifference to a clear uptrend indicates that uptrend has the ability to move higher. Commodities are in an uptrend and sentiment analysis shows that the long side is not too crowded.
by: Wall St. Cheat Sheet December 21, 2010
By Jordan Roy-Byrne
Even though Commodities as per the CCI are within 2% of an all-time high (and at an all-time high when priced against a basket of foreign currencies), there is absolutely no sign of a bubble or froth in the commodity complex. Various data will show that both Commodities and the commodity stocks are under-owned and have more room to rise.
One way to measure the value of a sector is to look at a sector’s overall size as a percentage of the S&P 500 (NYSE: SPY). The chart below is from Ryan Puplava of PFS Group. It is a bit dated, but as of today Energy and Materials comprise 15% of the S&P 500. The 2008 peak was about 19%. The 1980 peak was 43% while Technology peaked at 35% in 2000 and Financials and Consumer Discretionary accounted for 35% of the S&P 500 in 2005.
In addition, some sentiment indicators show there is little interest in Commodities. Assets in the Rydex Commodities fund (c/o of Sentimentrader) were over $300 million at the 2008 peak and dwindled to as low as $40 million. The CCI has recovered to near an all-time high and even the CRB is at a two-year high, yet assets in the fund are only $43 million! Moreover, we can clearly see what happens in a bubble as in 2008, assets surged about 300% in six months.
Also from Sentimentrader, we see 59% surveyed as bullish on Commodities. While this is a two-year high, it is well below the levels of 2006-2008.
Despite the solid performance of the commodity sector, investors don’t seem to be enthusiastic. For one, the stocks comprise 15% of the S&P 500 compared to 19% in 2008. Perhaps investors don’t want to get burned again as in 2008? Perhaps they like the safety of bonds more (which fund flows do indicate)?
In any event, contrary analysis tells us that skepticism, a wall of worry or outright indifference to a clear uptrend indicates that uptrend has the ability to move higher. Commodities are in an uptrend and sentiment analysis shows that the long side is not too crowded.
Tuesday, 21 December 2010
Be Fearful When Others Are Greedy...
I am a little nervous of stock markets now, especially in emerging markets and Asia ex Japan. Every parent, neighbour and her dog is in emerging markets. Analysts are so bullish that every day we see "Buy Emerging Market Stocks" on newspapers. When markets are this bullish, I'm usually very nervous. Oh, and certain indicators that I'm looking at have crept up. Not good news. I don't think the bull run will end. I just think another bigger correction (than the latest which fell by 7%) is due.
I suggest taking some profits if they are over 20% in return. A profit is not a profit till you have pocketed it.
Why I'm Expecting a Huge Rally...
by: Jeff Pierce December 20, 2010
…but I also think it’ll be short lived to trick the masses.
Below are the links from the video.
•Financial Armegeddon http://www.financialarmageddon.com/2010/12/full-house.html
•Value Walk http://www.valuewalk.com/aii-surveys/sentiment-update-warning-distant/
•Traders Narrative http://tradersnarrative.wordpress.com/2010/12/17/sentiment-overview-week-of-december-17th-2010/#more-218
•Stockcharts http://blogs.stockcharts.com/chartwatchers/2010/12/market-poised-to-correct.html
I suggest taking some profits if they are over 20% in return. A profit is not a profit till you have pocketed it.
Why I'm Expecting a Huge Rally...
by: Jeff Pierce December 20, 2010
…but I also think it’ll be short lived to trick the masses.
Below are the links from the video.
•Financial Armegeddon http://www.financialarmageddon.com/2010/12/full-house.html
•Value Walk http://www.valuewalk.com/aii-surveys/sentiment-update-warning-distant/
•Traders Narrative http://tradersnarrative.wordpress.com/2010/12/17/sentiment-overview-week-of-december-17th-2010/#more-218
•Stockcharts http://blogs.stockcharts.com/chartwatchers/2010/12/market-poised-to-correct.html
Tuesday, 14 December 2010
Why It Is Safe to Buy Citigroup Again
I have made several big killings in the last 2 years. One of them is buying Las Vegas Sands at USD6, 12, 24 and 36. I took some profits along the way. But the profit is a nice tidy sum. Not enough to retire, because I've made some mistakes along the way. Las Vegas has now entered a consolidation stage. It may remain at between 45 - 50 for several months before breaking a new high. It should make that new high early next year.
The second big bet I made was in Citigroup. I bought it at USD3.50 and 4.50. Watch for it.
MGM is an interesting US play. It has been a laggard and rightly so; it has the biggest market share in the Las Vegas Strip. The US consumer/gaming play will take a long time to turnaround. Meanwhile, MGM could be a stock waiting to burst out like Las Vegas Sands. But I doubt if it can do what LVS has done. It is in the wrong market. Still, a one bagger is better than nothing.
There were many other big bets that paid off. My forays into Chinese mining companies in 2009, into US/Canadian mining companies this year. My bets in local construction companies / property developers have yet to pay off in a big way.
Why It's Safe to Buy Citigroup Stock Once Again
by: StreetAuthority December 12, 2010
by David Sterman
Uncle Sam's decision to unload its remaining block of 2.4 billion common shares of Citigroup (NYSE: C) -- one quarter ahead of time -- has caused many to take a fresh look at the banking titan. A quick survey of analysts' opinions reveals a stock with +15% or +20% upside from here. Yet as you dig deeper, you'll see why Citigroup can actually spike well higher -- perhaps rising +50% or more in the next two years (my take: Citi will double in a year).
A continuing clean-up
Make no mistake, Citigroup is still hurting. The damage from the 2008 crisis was so deep that management will be spending another year -- or more -- cleaning up the mess. They've started the process by creating "Good Citi" and "Bad Citi," otherwise known as Citicorp and Citi Holdings. Citicorp holds all the assets that we'll be talking about a few years from now. Citi Holdings contains a hodge-podge of assets that management hopes to eventually sell, including retail partner credit cards, CitiMortgage, private student lending, brokerage and a group of pooled assets.
There are two items to note about these unwanted assets. First, Citigroup is carrying them on its books at levels likely below fair market value. So the bank's tangible book value of $4.44 is understated. Second, as the economy improves, so will the likely value of these assets. Management is in no hurry to simply hold a fire sale, so it may be several years before the process is complete.
The road ahead
The remaining assets (Good Citi) are what investors will be focusing on. And there's a lot to love. Citigroup aims to get back to the old-fashioned business of banking, providing advice, facilitating global transactions and generally playing it safe. The days of throwing money after the latest financial gimmicks are over. CEO Vikram Pandit, who seemed to be a poster child of financial recklessness a few years ago, now appears to be the most sober-minded executive in the business.
Pandit is staking his claim on Citigroup returning to its historical role of consumer banking and advice. And we're again reminded that banking is a nice business. Citigroup lost $7.8 billion in 2009 as many assets were written down, but it is likely to generate more than $14 billion in operating profit this year. Pandit's goal is to boost that figure well higher in coming years. To get there, he's making a big push into Asia, Latin America and Africa.
Judging by recent results, Citigroup is making major inroads in some of the most dynamic regions and countries in the world. In the most recent quarter, Latin America-derived revenue rose +8%, while Asia-derived revenue rose +17%. Right now, North America and Europe constitute about two-thirds of revenue. But emerging markets are expected to grow at a faster pace than Europe and North America in coming years, so that revenue mix may move closer to 50/50.
The emerging market focus isn't on the rising middle class in these countries. Instead, it is on those in upper income segments, as well as corporations. So much wealth is being created in places like Brazil and China right now that the ranks of millionaires is likely to keep swelling. And that's Citigroup's bread and butter. From private banking to corporate advisory services, Pandit is focusing Citigroup on the highest margin businesses.
By the numbers
Shares of Citigroup have traded between $3 and $5 in the past year. And after a recent spike, they currently hover around $4.60. But I see a move up to $7 by early 2012. Here's how we get there…
First, Citigroup needs to keep shedding the divisions housed in Citi Holdings (Bad Citi). That could take anywhere from 12 to 36 months to complete. As noted, a patient disposition of those assets should yield sale prices above the level they are being carried on Citi's books.
Second, with increased financial flexibility, look for deals that expand the company's footprint in emerging markets. (That financial flexibility is noted by a 10.3% Tier One Capital ratio, the highest among any major bank, and well above regulatory minimums). Third, look for the U.S. and European economies to start to perk back to life in the next six to 18 months. As signs of life emerge in these two large economic regions, investors are likely to reward bank stocks with higher price-to-book multiples.
Right now, shares of Citigroup trade right around book value, which is $4.44. The bank is generating impressive 20%-plus returns on its equity base, and book value could exceed $5.50 by the middle of 2012. By then, a more bullish take on bank stocks could lead to target price-to-book multiples to rise up to 1.5. That would push shares of Citigroup past $8.
By 2012, Citigroup will also likely be buying back stock, boosting its dividend, or both. Based on 2011 profit forecasts, Citigroup can afford to pay out $0.35 to $0.45 in dividends. Assume it's the lower end of that range, and assume that investors own the stock for a 5% yield. That translates into a $7 stock.
It's been a brutal slog for Citigroup, and the struggle isn't over just yet. The U.S. economy remains weak, and the company needs to keep working to clean up its balance sheet by unloading those unwanted assets.
If the economy stays weak for an extended period and Citigroup can't find any takers for those assets, then shares are likely dead money for the next few years. But if the stars align, then investors are looking at +50% or even +70% upside. That will take several years to accomplish, so this is a "buy-and-hold" stock and not a quick trade. But one thing's for sure, it's safe again to be a buyer of Citigroup.
The second big bet I made was in Citigroup. I bought it at USD3.50 and 4.50. Watch for it.
MGM is an interesting US play. It has been a laggard and rightly so; it has the biggest market share in the Las Vegas Strip. The US consumer/gaming play will take a long time to turnaround. Meanwhile, MGM could be a stock waiting to burst out like Las Vegas Sands. But I doubt if it can do what LVS has done. It is in the wrong market. Still, a one bagger is better than nothing.
There were many other big bets that paid off. My forays into Chinese mining companies in 2009, into US/Canadian mining companies this year. My bets in local construction companies / property developers have yet to pay off in a big way.
Why It's Safe to Buy Citigroup Stock Once Again
by: StreetAuthority December 12, 2010
by David Sterman
Uncle Sam's decision to unload its remaining block of 2.4 billion common shares of Citigroup (NYSE: C) -- one quarter ahead of time -- has caused many to take a fresh look at the banking titan. A quick survey of analysts' opinions reveals a stock with +15% or +20% upside from here. Yet as you dig deeper, you'll see why Citigroup can actually spike well higher -- perhaps rising +50% or more in the next two years (my take: Citi will double in a year).
A continuing clean-up
Make no mistake, Citigroup is still hurting. The damage from the 2008 crisis was so deep that management will be spending another year -- or more -- cleaning up the mess. They've started the process by creating "Good Citi" and "Bad Citi," otherwise known as Citicorp and Citi Holdings. Citicorp holds all the assets that we'll be talking about a few years from now. Citi Holdings contains a hodge-podge of assets that management hopes to eventually sell, including retail partner credit cards, CitiMortgage, private student lending, brokerage and a group of pooled assets.
There are two items to note about these unwanted assets. First, Citigroup is carrying them on its books at levels likely below fair market value. So the bank's tangible book value of $4.44 is understated. Second, as the economy improves, so will the likely value of these assets. Management is in no hurry to simply hold a fire sale, so it may be several years before the process is complete.
The road ahead
The remaining assets (Good Citi) are what investors will be focusing on. And there's a lot to love. Citigroup aims to get back to the old-fashioned business of banking, providing advice, facilitating global transactions and generally playing it safe. The days of throwing money after the latest financial gimmicks are over. CEO Vikram Pandit, who seemed to be a poster child of financial recklessness a few years ago, now appears to be the most sober-minded executive in the business.
Pandit is staking his claim on Citigroup returning to its historical role of consumer banking and advice. And we're again reminded that banking is a nice business. Citigroup lost $7.8 billion in 2009 as many assets were written down, but it is likely to generate more than $14 billion in operating profit this year. Pandit's goal is to boost that figure well higher in coming years. To get there, he's making a big push into Asia, Latin America and Africa.
Judging by recent results, Citigroup is making major inroads in some of the most dynamic regions and countries in the world. In the most recent quarter, Latin America-derived revenue rose +8%, while Asia-derived revenue rose +17%. Right now, North America and Europe constitute about two-thirds of revenue. But emerging markets are expected to grow at a faster pace than Europe and North America in coming years, so that revenue mix may move closer to 50/50.
The emerging market focus isn't on the rising middle class in these countries. Instead, it is on those in upper income segments, as well as corporations. So much wealth is being created in places like Brazil and China right now that the ranks of millionaires is likely to keep swelling. And that's Citigroup's bread and butter. From private banking to corporate advisory services, Pandit is focusing Citigroup on the highest margin businesses.
By the numbers
Shares of Citigroup have traded between $3 and $5 in the past year. And after a recent spike, they currently hover around $4.60. But I see a move up to $7 by early 2012. Here's how we get there…
First, Citigroup needs to keep shedding the divisions housed in Citi Holdings (Bad Citi). That could take anywhere from 12 to 36 months to complete. As noted, a patient disposition of those assets should yield sale prices above the level they are being carried on Citi's books.
Second, with increased financial flexibility, look for deals that expand the company's footprint in emerging markets. (That financial flexibility is noted by a 10.3% Tier One Capital ratio, the highest among any major bank, and well above regulatory minimums). Third, look for the U.S. and European economies to start to perk back to life in the next six to 18 months. As signs of life emerge in these two large economic regions, investors are likely to reward bank stocks with higher price-to-book multiples.
Right now, shares of Citigroup trade right around book value, which is $4.44. The bank is generating impressive 20%-plus returns on its equity base, and book value could exceed $5.50 by the middle of 2012. By then, a more bullish take on bank stocks could lead to target price-to-book multiples to rise up to 1.5. That would push shares of Citigroup past $8.
By 2012, Citigroup will also likely be buying back stock, boosting its dividend, or both. Based on 2011 profit forecasts, Citigroup can afford to pay out $0.35 to $0.45 in dividends. Assume it's the lower end of that range, and assume that investors own the stock for a 5% yield. That translates into a $7 stock.
It's been a brutal slog for Citigroup, and the struggle isn't over just yet. The U.S. economy remains weak, and the company needs to keep working to clean up its balance sheet by unloading those unwanted assets.
If the economy stays weak for an extended period and Citigroup can't find any takers for those assets, then shares are likely dead money for the next few years. But if the stars align, then investors are looking at +50% or even +70% upside. That will take several years to accomplish, so this is a "buy-and-hold" stock and not a quick trade. But one thing's for sure, it's safe again to be a buyer of Citigroup.
Saturday, 11 December 2010
Is There An Alternative to the Western Political Model?
I am a strong advocate of free but responsible, informed speech. I don't believe in jailing someone for their political thoughts, unless he advocates violence or hatred. I strongly believe in a free but responsible press, and a free election.
However, the last 10 years I have seen how western democracy has degenerated into a farce. In the US, Obama tried to reform healthcare and cut taxes for the middle-class. All the Republicans want is to make sure Obama doesn't get a second term. They are not interested in making America strong. Republicans are backed by strong corporate lobbyists, by the National Rifle Association, the Religious Right, the arms industry. They propogate half-truths about what Obama is trying to do. The Republicans are also anti-environmental protection. The Kyoto Protocol will never be ratified as long as the Republicans have a say. It's incredible that half of America forget that it was under Bush junior that their fiscal surplus was turned into a massive deficit. Under Bush, they fought a unjust war in Iraq looking for weapons of mass destruction without fruit. If a Republican president gains power in 2012, it will be the Democrats' to turn on the power incumbent. The Republicans had great president. Ronald Reagan brought rampant spending under control in the 80s after a series of ineffective and spendthrift Democratic presidents. But since the 90s, the Democrats have shifted to the centre. If the Americans choose Republicans, they choose war, global warming and the demise of all.
In Europe, decades of democratic rule, socialist/communist parties have come into power. In many European countries, dangerous anti-immigrant right-wing parties have come into power. Many of these parties have nothing but promises of free education, high taxes, high unemployment benefits, free healthcare. But there's no free lunch. The Portugal, Ireland, Italy, Greece, Spain and Belgium are finally admitting fiscal deficits larger than their GDP can handle.
The result of one-man-one-vote is a sprial towards petty politics with parties only interested in immediate results without a care for long-term implications.
I don't have an answer to this. Perhaps the answer lies in giving the person who pays more taxes slightly more votes. If person A pays S$50k per annum in taxes, he should have twice the number of votes as a person who pays only S$5k. This is not a perfect system. There are many important interests that may not be met by such a system. For example, how will environmental protection be looked after by such a system? After all, the one who pays the most taxes may not more interested in protecting the environment than say a fresh graduate who pays little taxes. It's open for discussion.
However, the last 10 years I have seen how western democracy has degenerated into a farce. In the US, Obama tried to reform healthcare and cut taxes for the middle-class. All the Republicans want is to make sure Obama doesn't get a second term. They are not interested in making America strong. Republicans are backed by strong corporate lobbyists, by the National Rifle Association, the Religious Right, the arms industry. They propogate half-truths about what Obama is trying to do. The Republicans are also anti-environmental protection. The Kyoto Protocol will never be ratified as long as the Republicans have a say. It's incredible that half of America forget that it was under Bush junior that their fiscal surplus was turned into a massive deficit. Under Bush, they fought a unjust war in Iraq looking for weapons of mass destruction without fruit. If a Republican president gains power in 2012, it will be the Democrats' to turn on the power incumbent. The Republicans had great president. Ronald Reagan brought rampant spending under control in the 80s after a series of ineffective and spendthrift Democratic presidents. But since the 90s, the Democrats have shifted to the centre. If the Americans choose Republicans, they choose war, global warming and the demise of all.
In Europe, decades of democratic rule, socialist/communist parties have come into power. In many European countries, dangerous anti-immigrant right-wing parties have come into power. Many of these parties have nothing but promises of free education, high taxes, high unemployment benefits, free healthcare. But there's no free lunch. The Portugal, Ireland, Italy, Greece, Spain and Belgium are finally admitting fiscal deficits larger than their GDP can handle.
The result of one-man-one-vote is a sprial towards petty politics with parties only interested in immediate results without a care for long-term implications.
I don't have an answer to this. Perhaps the answer lies in giving the person who pays more taxes slightly more votes. If person A pays S$50k per annum in taxes, he should have twice the number of votes as a person who pays only S$5k. This is not a perfect system. There are many important interests that may not be met by such a system. For example, how will environmental protection be looked after by such a system? After all, the one who pays the most taxes may not more interested in protecting the environment than say a fresh graduate who pays little taxes. It's open for discussion.
Mr China: Memoirs
For anyone who wish to do business in China, this book is a must-read. It's funny, it's so true. It's the way China works and you either adapt or die.
There is also a blog on doing biz in China:
http://managingthedragon.com/
What we need now is a similar book on Russia and Indonesia.
There is also a blog on doing biz in China:
http://managingthedragon.com/
What we need now is a similar book on Russia and Indonesia.
Why the Market Multiple Will be Higher in 2011
Why the Market Multiple Will be Higher in 2011
by: Jeff Miller December 10, 2010
Market relationships differ depending upon the time frame. Right now, higher bond yields are bullish for stocks. This article explains why.
The most important question for equity investors relates to rising interest rates and the implications for stocks. Nearly everyone (including us) agrees that long-term rates are moving higher. That has been the recent move and it implies significant capital losses for those holding long bonds. Here is a nice analysis of the risk by John Lounsbury.
Several pundits have weighed in on the effect of an interest rate increase. Let us take a closer look.
Background
On a theoretical basis, lower interest rates are bullish for stocks. Companies can borrow more cheaply. The choice for those doing asset allocation tilts toward equities. The data support the traditional stock/bond relationship - usually.
But these are not typical times. Higher interest rates may be consistent with higher stock multiples. Abnormal Returns covers the topic and also highlights other sites on bond yields. I want to go beyond the generalized arguments and look to some strong supporting data.
Exceptional Periods
There are circumstances where the relationship is reversed, when higher bond yields are actually correlated with higher stock prices. Several commentators have suggested that this might be such a time, but I always like to look at the data.
We have seen this before....
We had a similar situation in 2004. A top analyst from a major firm, drawing upon the help of his entire team, developed a regression model relating bond and stock prices. The research team facilitated their analysis by throwing out data that did not fit their thesis. As usual, it was a mistake to begin the research with a pre-destined conclusion in mind.
This research was actually one of the things that inspired me to start blogging. I figured that if the proprietary research by big firms has such major flaws, there had to be room for people who had strong and discplined methods. You can check out my old article (one of my favorites) by looking for the initial reader challenge here (no one solved the problem then, and you won't now) or the full exposure of the big firm's blunder here.
If you want to see the entire logic -- and you should -- check out the full article. It required more hours of research than any other piece I have ever done. Meanwhile, here is the key finding:
The relationship between stocks and bonds is curvilinear. In the "normal" range of interest rates, stocks and bonds trade as expected. When interest rates fall to a an extremely low level, the relationship breaks down. Why? The very low interest rates reflect deflation concerns and extreme skepticism about earnings from stocks.
Here is the relationship (click to enlarge):
The historical data show the relationship between stocks and bonds. The chart highlights two distinct anamolous periods. Please note that I am not just throwing out data. Analysts (and readers) are free to draw whatever conclusions seem appropriate. The chart facilitates your analysis rather than forcing you into a conclusion. If you read the entire article you will see five different views of the same data. It shows the difficulty of the task.
My Conclusion
The evidence shows a long-term relationship between the forward earnings yield and bond yields. This is what we would expect.
When bond yields get very low, the relationship breaks down. This also makes sense. Yields have been very low twice in the last decade, both times when there were extreme deflation fears. Under those circumstances there is intense skepticism about future earnings forecasts, so the multiple is low.
Investment Conclusion
We are currently at the unusual tipping point in the relationship. The emerging consensus about improving economic prospects is having two effects: higher long-term bond yields and more confidence in earnings.
The implication is that stocks will get a higher multiple in 2011 as confidence improves. This is not merely speculation, but a conclusion based upon the data cited.
If the market were to embrace this traditional relationship, the forward earnings multiple would be in the 20's. This suggests an S&P 500 value that is 50% higher (or more) than current levels.
I am not making this as a prediction, since the climate of fear has cast a negative spell upon earnings. Who knows how long this will last? I have often suggested that low market multiples are the best single gauge of investor sentiment. I do predict that the path of least resistance is higher, and it could be much higher.
The summary:
Higher bond yields imply more economic confidence and a higher stock multiple.
You heard it here first, including when I highlighted the topic in the gloomy days of August.
by: Jeff Miller December 10, 2010
Market relationships differ depending upon the time frame. Right now, higher bond yields are bullish for stocks. This article explains why.
The most important question for equity investors relates to rising interest rates and the implications for stocks. Nearly everyone (including us) agrees that long-term rates are moving higher. That has been the recent move and it implies significant capital losses for those holding long bonds. Here is a nice analysis of the risk by John Lounsbury.
Several pundits have weighed in on the effect of an interest rate increase. Let us take a closer look.
Background
On a theoretical basis, lower interest rates are bullish for stocks. Companies can borrow more cheaply. The choice for those doing asset allocation tilts toward equities. The data support the traditional stock/bond relationship - usually.
But these are not typical times. Higher interest rates may be consistent with higher stock multiples. Abnormal Returns covers the topic and also highlights other sites on bond yields. I want to go beyond the generalized arguments and look to some strong supporting data.
Exceptional Periods
There are circumstances where the relationship is reversed, when higher bond yields are actually correlated with higher stock prices. Several commentators have suggested that this might be such a time, but I always like to look at the data.
We have seen this before....
We had a similar situation in 2004. A top analyst from a major firm, drawing upon the help of his entire team, developed a regression model relating bond and stock prices. The research team facilitated their analysis by throwing out data that did not fit their thesis. As usual, it was a mistake to begin the research with a pre-destined conclusion in mind.
This research was actually one of the things that inspired me to start blogging. I figured that if the proprietary research by big firms has such major flaws, there had to be room for people who had strong and discplined methods. You can check out my old article (one of my favorites) by looking for the initial reader challenge here (no one solved the problem then, and you won't now) or the full exposure of the big firm's blunder here.
If you want to see the entire logic -- and you should -- check out the full article. It required more hours of research than any other piece I have ever done. Meanwhile, here is the key finding:
The relationship between stocks and bonds is curvilinear. In the "normal" range of interest rates, stocks and bonds trade as expected. When interest rates fall to a an extremely low level, the relationship breaks down. Why? The very low interest rates reflect deflation concerns and extreme skepticism about earnings from stocks.
Here is the relationship (click to enlarge):
The historical data show the relationship between stocks and bonds. The chart highlights two distinct anamolous periods. Please note that I am not just throwing out data. Analysts (and readers) are free to draw whatever conclusions seem appropriate. The chart facilitates your analysis rather than forcing you into a conclusion. If you read the entire article you will see five different views of the same data. It shows the difficulty of the task.
My Conclusion
The evidence shows a long-term relationship between the forward earnings yield and bond yields. This is what we would expect.
When bond yields get very low, the relationship breaks down. This also makes sense. Yields have been very low twice in the last decade, both times when there were extreme deflation fears. Under those circumstances there is intense skepticism about future earnings forecasts, so the multiple is low.
Investment Conclusion
We are currently at the unusual tipping point in the relationship. The emerging consensus about improving economic prospects is having two effects: higher long-term bond yields and more confidence in earnings.
The implication is that stocks will get a higher multiple in 2011 as confidence improves. This is not merely speculation, but a conclusion based upon the data cited.
If the market were to embrace this traditional relationship, the forward earnings multiple would be in the 20's. This suggests an S&P 500 value that is 50% higher (or more) than current levels.
I am not making this as a prediction, since the climate of fear has cast a negative spell upon earnings. Who knows how long this will last? I have often suggested that low market multiples are the best single gauge of investor sentiment. I do predict that the path of least resistance is higher, and it could be much higher.
The summary:
Higher bond yields imply more economic confidence and a higher stock multiple.
You heard it here first, including when I highlighted the topic in the gloomy days of August.
Friday, 10 December 2010
A Multi-Asset Investment Strategy for Individual Investors
A Multi-Asset Investment Strategy for Individual Investors
by: Henry Ma December 08, 2010
Modern finance theory has taught us two very useful lessons in investments. The first is that diversification improves risk/return profile. The second is that there are long-lasting trends in financial markets, either as a result of over-reaction or under-reaction to the changes of fundamentals by the market participants, or due to the cyclical behavior of business and economic conditions.
In this article, I will show you how to construct a multi-asset portfolio to achieve a better diversification as well as how to use some simple indicators to identify market trends and improve your market timing skills.
Multi-Asset Portfolio (MAP)
Traditionally, asset allocation has been focusing on stocks and bonds. This approach in general does not provide adequate diversification in an investor’s portfolio. Statistically speaking, adding more asset classes can always improve the risk/return profile as long as correlations are not one. Here, I propose a ten-asset portfolio to match the allocation of traditional 60/40 equity/bond portfolio as follows:
•Risky assets (60%)
•S&P 500 Index (SPY): 15%
•MSCI EAFE Index (EFA): 10%
•MSCI Emerging Market Index (EEM): 10%
•IBOXX High Yield Bond Index (HYG): 5%
•J.P Morgan Emerging Market Bond Index (EMB): 5%
•Dow Jones UBS Commodity Index (DJP): 5%
•Gold Index (GLD): 5%
•Dow Jones US REIT (IYR): 5%
•Bonds (40%)
•Barclays US Aggregate Bond Index (AGG): 35%
•US 3-month Treasury Bill: 5%.
The major advantage of this multi-asset portfolio (MAP) is that it replaces the 60% equity allocation with more diversified risky asset classes such as international equities, emerging market equities, commodities, high yield bonds, emerging market bonds and real estate.
Historically, this portfolio has a much better risk/return profile than traditional 60/40 equity/bond benchmark as shown in Table 1. The 60/40 equity/bond benchmark is constructed with 60% in S&P 500 Index and 40% Barclays US Aggregate Bond Index.
During the last ten years, the multi-asset portfolio delivered a higher return with lower volatility and downside risk. Conventional wisdom says “diversification is the only free lunch in investments”. It works here! As a word of caution, I don’t expect we can always achieve a higher return, but I do expect diversification will reduce risk without dampening much of the return.
Another advantage is that this portfolio can be easily implemented with liquid exchange-trade funds (ETFs) in a cost-effective way. Rather than try to pick stocks or mutual funds, investors can focus more on asset allocation across a broad range of assets. As we all know, asset allocation is the most important factor in determining our portfolio return in the long run.
Table 1: Performance of MAP vs. 60/40 Equity/Bond Benchmark
(1999-2010)**
Year MAP 60/40 Equity
/Bond Excess Return (MAP - 60/40 Equity/Bond)
1999 13.2% 12.0% 1.2%
2000 0.9% -1.0% 1.9%
2001 -1.2% -3.7% 2.5%
2002 0.4% -9.8% 10.2%
2003 20.4% 18.5% 2.0%
2004 10.9% 8.3% 2.6%
2005 9.3% 4.0% 5.3%
2006 13.6% 11.1% 2.5%
2007 9.8% 6.2% 3.6%
2008 -20.8% -22.1% 1.3%
2009 23.8% 18.4% 5.4%
2010 10.3% 8.5% 1.8%
Annualized Average Return 7.2% 4.0% 3.2%
Annualized Standard Deviation 8.6% 9.8% 4.3%
Multi-Asset Timing Strategy (MATS)
There are numerous fundamental and technical indicators that people use to create market-timing strategy. Three simple indicators I have found most useful in identifying market trends and business cycles are ISM Manufacturing Index, yield curve and market trend.
ISM Manufacturing Index is an extremely important indicator for the markets as it provides a timely measure of manufacturing activities. It also called Purchasing Manager Index (PMI). The PMI has been issued since 1948 by the Institute for Supply Management. On a monthly basis, ISM collects data through a survey of 400 purchasing managers in the manufacturing sector on five different fields, i.e., production level, new orders from customers, speed of supplier deliveries, inventories and employment level. Participants report either better, same or worse conditions than previous months. A PMI number higher than 50 means expansion in manufacturing activities. A lower number means contraction. Normally, risky asset markets perform well in an expanding economy.
Yield Curve is a reliable indicator of market liquidity and monetary condition. The Fed manages monetary policy by adjusting short-term interest rates. When economy slows, the Fed tends to lower the short-term rate and the yield curve steepens. On the other hand, when economy peaks and inflation accelerates, the Fed tends to raise the interest rate and the yield curve flattens. In this article, I define yield curve as the spread between ten-year Treasury rate and three-month T-bill rate. When the yield curve is upward-sloping, i.e. the short-term interest rates are lower than the long-term interest rates, the monetary policy is relatively loose and liquidity is ample in the market. On the other hand, when the yield curve is flat or downward-sloping, the monetary policy is tight and liquidity is constrained. Other things being equal, investors will seek higher returns by purchasing risky assets when liquidity and cheap money are plenty.
Market Trend is the most important concept in technical analysis. The markets are composed of alterations between upward trends (bull markets) and downward trends (bear markets). This phenomenon reflects the cyclical pattern of the underlying economy. Furthermore, investors’ behavior biases extend the market trends both in the upside and in the downside. Trend-following strategy has proved to work in the past and will continue to work in the future as the underlying market pattern will not change. I use a proprietary indicator to define market trend, however, any investor can use 10-month simple moving average (SMA) as suggested by Mebane Faber*. When the current price is higher than 10-month SMA, the market is on an uptrend and vice versa. The market tends to continue to move in the direction of the existing trend. To make trend-following strategy work, investors have to be disciplined. Once the market trend reverses, investors need to shift their positions.
Table 2 summarizes how I use the three indicators to time the markets. The ideal time to invest in risky assets is when the market is in an up trend, economy is expanding, and liquidity is ample. As a rule of thumb, among the three indicators, I over-weigh risky assets if two of them are positive and vice versa.
Table 3 shows the historical performance of the multi-asset timing strategy (MATS). The trading rule here is:
•Increase the allocation in the risky asset(s) by 5% in the multi-asset portfolio if the timing model indicates over-weight;
•Decrease the allocation in the risky asset(s) by 5% in the multi-asset portfolio if the timing model indicates under-weight;
•Residual allocation goes to bonds.
The results are impressive. MATS beats the 60/40 equity/bond benchmark by an average of 7.4% every year in the last ten years. The strategy also reduced the downside risk dramatically in the bear markets of 2002 and 2008. If an investor had followed the strategy, the “lost decade” might have been the time to celebrate.
Table 2: Multi-Asset Timing Strategy
Market Trend ISM Manufacturing Index Yield Curve Risky Asset Strategy
UP >50 Upward-sloping Over-weigh
UP >50 Downward-sloping Over-weigh
UP <50 Upward-sloping Over-weigh
UP <50 Downward-sloping Under-weigh
DOWN >50 Upward-sloping Over-weigh
DOWN >50 Downward-sloping Under-weigh
DOWN <50 Upward-sloping Under-weigh
DOWN <50 Downward-sloping Under-weigh
Table 3: Performance of Multi-asset Timing Strategy
(2000-2010)**
Date MATS 60/40 Equity
/Bond Excess Return (MATS - 60/40 Equity/Bond)
2000 3.8% -1.0% 4.3%
2001 1.2% -3.7% 4.3%
2002 -2.7% -9.8% 7.6%
2003 28.6% 18.5% 8.6%
2004 15.3% 8.3% 6.6%
2005 13.7% 4.0% 9.5%
2006 17.4% 11.1% 5.7%
2007 12.8% 6.2% 6.3%
2008 -11.0% -22.1% 12.9%
2009 33.0% 18.4% 11.7%
2010 12.5% 8.5% 4.0%
Annualized Average Return 10.7% 3.3% 7.4%
Annualized Standard Deviation 9.4% 9.9% 6.4%
Portfolio Recommendation for December 2010
As individual investors have a limited amount of time to research or follow the markets, I will show you how to implement the strategy step by step in half an hour at the beginning of each month. The steps include the following:
•Determine your target multi-asset portfolio (MAP). If you are happy with 60/40 allocation, you can use my targets.
•Define the market trends. Go to yahoo.com and look for information on the ETFs listed above. Compare the current price with 200-day moving average.
•Get ISM Manufacturing Index data on the first business day of the month on the ISM website.
•Find yield curve data on Bloomberg.com.
•Use Table 2 to determine your weights and implement the allocations through ETFs.
In the meantime, to help individual investors, I plan to publish my recommendations at the beginning of every month on Seeking Alpha. Rather than 10-month moving average, I will use a proprietary indicator to reduce the time lag of the moving average. In addition, I may over-ride the model based on my view on economic cycle and market valuation from time to time. On December 1, the ISM Manufacturing Index was reported at 56.6. The spread between ten-year Treasury rate and 3-month T-Bill was at 2.80%, indicating a steep upward-sloping yield curve. All the risky assets are still in upward trends.
I believe the economy is in a recovery/expansion stage. Although the tensions in the Korean peninsula and European debt crisis pose risks in the financial markets, they will not derail the global economy recovery and reverse the market trends. I recommend over-weighting risky assets:
•Risky assets (100%)
•S&P 500 Index (SPY): 20%
•MSCI EAFE Index (EFA): 15%
•MSCI Emerging Market Index (EEM): 15%
•IBOXX High Yield Bond Index (HYG): 10%
•J.P Morgan Emerging Market Bond Index (EMB): 10%
•Dow Jones UBS Commodity Index (DJP): 10%
•Gold Index (GLD): 10%
•Dow Jones US REIT (IYR): 10%
•Bonds (0%)
•Barclays US Aggregate Bond Index (AGG): 0%
•US 3-month Treasury Bill: 0%.
Notes:
* Mebane Faber, “A Quantitative Approach to Tactical Asset Allocation”, ssrn.com
** Data sources in this article are Bloomberg, Yahoo and ISM.
*** The returns in the tables are gross returns. Return in 2010 is the return between 01/2010 and 10/2010.
Disclosure: Author is long EEM, HYG, EFA, SPY
by: Henry Ma December 08, 2010
Modern finance theory has taught us two very useful lessons in investments. The first is that diversification improves risk/return profile. The second is that there are long-lasting trends in financial markets, either as a result of over-reaction or under-reaction to the changes of fundamentals by the market participants, or due to the cyclical behavior of business and economic conditions.
In this article, I will show you how to construct a multi-asset portfolio to achieve a better diversification as well as how to use some simple indicators to identify market trends and improve your market timing skills.
Multi-Asset Portfolio (MAP)
Traditionally, asset allocation has been focusing on stocks and bonds. This approach in general does not provide adequate diversification in an investor’s portfolio. Statistically speaking, adding more asset classes can always improve the risk/return profile as long as correlations are not one. Here, I propose a ten-asset portfolio to match the allocation of traditional 60/40 equity/bond portfolio as follows:
•Risky assets (60%)
•S&P 500 Index (SPY): 15%
•MSCI EAFE Index (EFA): 10%
•MSCI Emerging Market Index (EEM): 10%
•IBOXX High Yield Bond Index (HYG): 5%
•J.P Morgan Emerging Market Bond Index (EMB): 5%
•Dow Jones UBS Commodity Index (DJP): 5%
•Gold Index (GLD): 5%
•Dow Jones US REIT (IYR): 5%
•Bonds (40%)
•Barclays US Aggregate Bond Index (AGG): 35%
•US 3-month Treasury Bill: 5%.
The major advantage of this multi-asset portfolio (MAP) is that it replaces the 60% equity allocation with more diversified risky asset classes such as international equities, emerging market equities, commodities, high yield bonds, emerging market bonds and real estate.
Historically, this portfolio has a much better risk/return profile than traditional 60/40 equity/bond benchmark as shown in Table 1. The 60/40 equity/bond benchmark is constructed with 60% in S&P 500 Index and 40% Barclays US Aggregate Bond Index.
During the last ten years, the multi-asset portfolio delivered a higher return with lower volatility and downside risk. Conventional wisdom says “diversification is the only free lunch in investments”. It works here! As a word of caution, I don’t expect we can always achieve a higher return, but I do expect diversification will reduce risk without dampening much of the return.
Another advantage is that this portfolio can be easily implemented with liquid exchange-trade funds (ETFs) in a cost-effective way. Rather than try to pick stocks or mutual funds, investors can focus more on asset allocation across a broad range of assets. As we all know, asset allocation is the most important factor in determining our portfolio return in the long run.
Table 1: Performance of MAP vs. 60/40 Equity/Bond Benchmark
(1999-2010)**
Year MAP 60/40 Equity
/Bond Excess Return (MAP - 60/40 Equity/Bond)
1999 13.2% 12.0% 1.2%
2000 0.9% -1.0% 1.9%
2001 -1.2% -3.7% 2.5%
2002 0.4% -9.8% 10.2%
2003 20.4% 18.5% 2.0%
2004 10.9% 8.3% 2.6%
2005 9.3% 4.0% 5.3%
2006 13.6% 11.1% 2.5%
2007 9.8% 6.2% 3.6%
2008 -20.8% -22.1% 1.3%
2009 23.8% 18.4% 5.4%
2010 10.3% 8.5% 1.8%
Annualized Average Return 7.2% 4.0% 3.2%
Annualized Standard Deviation 8.6% 9.8% 4.3%
Multi-Asset Timing Strategy (MATS)
There are numerous fundamental and technical indicators that people use to create market-timing strategy. Three simple indicators I have found most useful in identifying market trends and business cycles are ISM Manufacturing Index, yield curve and market trend.
ISM Manufacturing Index is an extremely important indicator for the markets as it provides a timely measure of manufacturing activities. It also called Purchasing Manager Index (PMI). The PMI has been issued since 1948 by the Institute for Supply Management. On a monthly basis, ISM collects data through a survey of 400 purchasing managers in the manufacturing sector on five different fields, i.e., production level, new orders from customers, speed of supplier deliveries, inventories and employment level. Participants report either better, same or worse conditions than previous months. A PMI number higher than 50 means expansion in manufacturing activities. A lower number means contraction. Normally, risky asset markets perform well in an expanding economy.
Yield Curve is a reliable indicator of market liquidity and monetary condition. The Fed manages monetary policy by adjusting short-term interest rates. When economy slows, the Fed tends to lower the short-term rate and the yield curve steepens. On the other hand, when economy peaks and inflation accelerates, the Fed tends to raise the interest rate and the yield curve flattens. In this article, I define yield curve as the spread between ten-year Treasury rate and three-month T-bill rate. When the yield curve is upward-sloping, i.e. the short-term interest rates are lower than the long-term interest rates, the monetary policy is relatively loose and liquidity is ample in the market. On the other hand, when the yield curve is flat or downward-sloping, the monetary policy is tight and liquidity is constrained. Other things being equal, investors will seek higher returns by purchasing risky assets when liquidity and cheap money are plenty.
Market Trend is the most important concept in technical analysis. The markets are composed of alterations between upward trends (bull markets) and downward trends (bear markets). This phenomenon reflects the cyclical pattern of the underlying economy. Furthermore, investors’ behavior biases extend the market trends both in the upside and in the downside. Trend-following strategy has proved to work in the past and will continue to work in the future as the underlying market pattern will not change. I use a proprietary indicator to define market trend, however, any investor can use 10-month simple moving average (SMA) as suggested by Mebane Faber*. When the current price is higher than 10-month SMA, the market is on an uptrend and vice versa. The market tends to continue to move in the direction of the existing trend. To make trend-following strategy work, investors have to be disciplined. Once the market trend reverses, investors need to shift their positions.
Table 2 summarizes how I use the three indicators to time the markets. The ideal time to invest in risky assets is when the market is in an up trend, economy is expanding, and liquidity is ample. As a rule of thumb, among the three indicators, I over-weigh risky assets if two of them are positive and vice versa.
Table 3 shows the historical performance of the multi-asset timing strategy (MATS). The trading rule here is:
•Increase the allocation in the risky asset(s) by 5% in the multi-asset portfolio if the timing model indicates over-weight;
•Decrease the allocation in the risky asset(s) by 5% in the multi-asset portfolio if the timing model indicates under-weight;
•Residual allocation goes to bonds.
The results are impressive. MATS beats the 60/40 equity/bond benchmark by an average of 7.4% every year in the last ten years. The strategy also reduced the downside risk dramatically in the bear markets of 2002 and 2008. If an investor had followed the strategy, the “lost decade” might have been the time to celebrate.
Table 2: Multi-Asset Timing Strategy
Market Trend ISM Manufacturing Index Yield Curve Risky Asset Strategy
UP >50 Upward-sloping Over-weigh
UP >50 Downward-sloping Over-weigh
UP <50 Upward-sloping Over-weigh
UP <50 Downward-sloping Under-weigh
DOWN >50 Upward-sloping Over-weigh
DOWN >50 Downward-sloping Under-weigh
DOWN <50 Upward-sloping Under-weigh
DOWN <50 Downward-sloping Under-weigh
Table 3: Performance of Multi-asset Timing Strategy
(2000-2010)**
Date MATS 60/40 Equity
/Bond Excess Return (MATS - 60/40 Equity/Bond)
2000 3.8% -1.0% 4.3%
2001 1.2% -3.7% 4.3%
2002 -2.7% -9.8% 7.6%
2003 28.6% 18.5% 8.6%
2004 15.3% 8.3% 6.6%
2005 13.7% 4.0% 9.5%
2006 17.4% 11.1% 5.7%
2007 12.8% 6.2% 6.3%
2008 -11.0% -22.1% 12.9%
2009 33.0% 18.4% 11.7%
2010 12.5% 8.5% 4.0%
Annualized Average Return 10.7% 3.3% 7.4%
Annualized Standard Deviation 9.4% 9.9% 6.4%
Portfolio Recommendation for December 2010
As individual investors have a limited amount of time to research or follow the markets, I will show you how to implement the strategy step by step in half an hour at the beginning of each month. The steps include the following:
•Determine your target multi-asset portfolio (MAP). If you are happy with 60/40 allocation, you can use my targets.
•Define the market trends. Go to yahoo.com and look for information on the ETFs listed above. Compare the current price with 200-day moving average.
•Get ISM Manufacturing Index data on the first business day of the month on the ISM website.
•Find yield curve data on Bloomberg.com.
•Use Table 2 to determine your weights and implement the allocations through ETFs.
In the meantime, to help individual investors, I plan to publish my recommendations at the beginning of every month on Seeking Alpha. Rather than 10-month moving average, I will use a proprietary indicator to reduce the time lag of the moving average. In addition, I may over-ride the model based on my view on economic cycle and market valuation from time to time. On December 1, the ISM Manufacturing Index was reported at 56.6. The spread between ten-year Treasury rate and 3-month T-Bill was at 2.80%, indicating a steep upward-sloping yield curve. All the risky assets are still in upward trends.
I believe the economy is in a recovery/expansion stage. Although the tensions in the Korean peninsula and European debt crisis pose risks in the financial markets, they will not derail the global economy recovery and reverse the market trends. I recommend over-weighting risky assets:
•Risky assets (100%)
•S&P 500 Index (SPY): 20%
•MSCI EAFE Index (EFA): 15%
•MSCI Emerging Market Index (EEM): 15%
•IBOXX High Yield Bond Index (HYG): 10%
•J.P Morgan Emerging Market Bond Index (EMB): 10%
•Dow Jones UBS Commodity Index (DJP): 10%
•Gold Index (GLD): 10%
•Dow Jones US REIT (IYR): 10%
•Bonds (0%)
•Barclays US Aggregate Bond Index (AGG): 0%
•US 3-month Treasury Bill: 0%.
Notes:
* Mebane Faber, “A Quantitative Approach to Tactical Asset Allocation”, ssrn.com
** Data sources in this article are Bloomberg, Yahoo and ISM.
*** The returns in the tables are gross returns. Return in 2010 is the return between 01/2010 and 10/2010.
Disclosure: Author is long EEM, HYG, EFA, SPY
Bond Vigilantes Are Finally Attacking the US!
Look at the 10y UST. Just 2 months ago, the UST 10y was around 2.5%. It has shot up to 3.3%. What's happening? The bond vigilantes are attacking the US. Bond investors no longer believe that the US government can repay back the bonds without drastically devaluing the USD.
Who are the culprits? Virtually anyone who has a stake in this. It could the Asian central governments, particularly the Chinese to get back at the US for lecturing them. It could be hedge funds. It could be the oil sheiks of the Middle East. It could be investors fearing inflation. Anyone.
What's going to happen? The US government will certainly defend the UST by buying up as much as they can to prevent yields from rising too fast. Don't worry, the US government can afford to buy up their UST as long as inflation is below 4%. It is good for stocks and commodities because investors who took profit on the US government can now recycle capital into more productive assets, like stocks and commodities.
The next surge in stocks and commodities has begun. The music will stop when inflation comes up. Nothing lasts forever.
Who are the culprits? Virtually anyone who has a stake in this. It could the Asian central governments, particularly the Chinese to get back at the US for lecturing them. It could be hedge funds. It could be the oil sheiks of the Middle East. It could be investors fearing inflation. Anyone.
What's going to happen? The US government will certainly defend the UST by buying up as much as they can to prevent yields from rising too fast. Don't worry, the US government can afford to buy up their UST as long as inflation is below 4%. It is good for stocks and commodities because investors who took profit on the US government can now recycle capital into more productive assets, like stocks and commodities.
Tuesday, 7 December 2010
Le Bouchons in Singapore and Wagyu Beef in Roppongi
Like eating beef?
Let me show you some places you'll never forget.
This is a Shabu Shabu restaurant in Roppongi, Tokyo. I can't read the sign but it was recommended by an Australian bouncer outside a Roppongi nightclub. Notice the price of Wagyu beef, about SGD15 for 2 boxes. The beef is beautifully marbelled. When I dip it in the broth for 1 minute and put it in my mouth, it just melts! The entire meal cost us less than SGD35 per pax.
Next, closer to home:
Les Bouchons
7 Ann Siang Road S(69689), Club Street
Tel: 6423 0737
Les Bouchons
Categories: Restaurant, French
7 Ann Siang Road S(69689), Club Street
Tel: 6423 0737
Monday, March 31, 2008
Les Bouchons @ Ann Siang Road
One of my favourite places to go for steaks is Les Bouchons @ Ann Siang Road. It's a small restaurant located within a quaint conservation shophouse. The red walls, warm lighting and cosy arrangement of the tables (read: set very close to each other) reminds me of a typical bistro in Paris. The above picture was taken from my seat next to the window. Yes, this is how small the place is. The capacity of the restaurant must be about 20. Reservations are highly recommended to avoid disappointment and a wasted trip.
I love the posters that they have on the walls. This restaurant is owned by the same people who own L'Angelus (my favourite rustic French restaurant). Their restaurants have a way of hitting the sweet spot for the Francophile in me. The menu is rather limited but the main focus for this place is Steak Frites (Steak and French Fries) so you should definitely order this when you visit. Joyce and I were there for our Plats (read: dishes) of Steak Frites (@ SGD28.80++).
After we'd placed our orders, we were served a basket of warm bread rolls and unsalted butter. I absolutely love unsalted butter as it allows me to savour the rich, creamy unadulterated subtle sweetness of fresh butter. Unsalted butter doesn't contain any preservatives unlike the salted versions (the salt levels are pretty high in some brands). Some food for thought in considering a switch from salted to unsalted butter. They serve Président Gastronomique here which I think tastes pretty close to the fresh farm-made butter that I enjoyed while travelling in Provence.
We were served bowls of salad (part of the set) which was a decent portion and was a refreshing mix of crisp salad greens with walnuts and rocket, drizzled with a tangy mustard vinaigrette dressing.
Here's a picture of the condiment platter which consists of mayonnaise, Dijon mustard, wholegrain mustard, horseradish and Maille's Bearnaise Sauce. I love mustard, especially with my fries! Man, I love this place!
Here's a picture of my Rib Eye (done medium rare) topped with a slab of herb butter and served with French fries. I love the steaks here as they're always cooked to perfection with fragrantly seared sides and juicy in the centre. The melted butter adds moisture and flavour to a deliciously tasty steak. The fries are not to be outdone either for they are consistently cooked to perfection. The exterior of the fries are crisp and the interior is fluffy, a perfect French Fry. Apparently the fries here are twice-cooked to achieve this result. I was told some years back that the fries are parboiled first then fried. Fries fans with hearty appetites will be happy to know that you can have unlimited servings of fries. I've not met a person who can go for seconds as we usually are unable to finish the portions on our plates. I'm usually too full after my steak and fries to go for desserts so I cannot comment on the quality of the desserts served here.
This place is definitely a MUST-TRY for steaks and fries!
Let me show you some places you'll never forget.
This is a Shabu Shabu restaurant in Roppongi, Tokyo. I can't read the sign but it was recommended by an Australian bouncer outside a Roppongi nightclub. Notice the price of Wagyu beef, about SGD15 for 2 boxes. The beef is beautifully marbelled. When I dip it in the broth for 1 minute and put it in my mouth, it just melts! The entire meal cost us less than SGD35 per pax.
Next, closer to home:
Les Bouchons
7 Ann Siang Road S(69689), Club Street
Tel: 6423 0737
Les Bouchons
Categories: Restaurant, French
7 Ann Siang Road S(69689), Club Street
Tel: 6423 0737
Monday, March 31, 2008
Les Bouchons @ Ann Siang Road
One of my favourite places to go for steaks is Les Bouchons @ Ann Siang Road. It's a small restaurant located within a quaint conservation shophouse. The red walls, warm lighting and cosy arrangement of the tables (read: set very close to each other) reminds me of a typical bistro in Paris. The above picture was taken from my seat next to the window. Yes, this is how small the place is. The capacity of the restaurant must be about 20. Reservations are highly recommended to avoid disappointment and a wasted trip.
I love the posters that they have on the walls. This restaurant is owned by the same people who own L'Angelus (my favourite rustic French restaurant). Their restaurants have a way of hitting the sweet spot for the Francophile in me. The menu is rather limited but the main focus for this place is Steak Frites (Steak and French Fries) so you should definitely order this when you visit. Joyce and I were there for our Plats (read: dishes) of Steak Frites (@ SGD28.80++).
We were served bowls of salad (part of the set) which was a decent portion and was a refreshing mix of crisp salad greens with walnuts and rocket, drizzled with a tangy mustard vinaigrette dressing.
Here's a picture of the condiment platter which consists of mayonnaise, Dijon mustard, wholegrain mustard, horseradish and Maille's Bearnaise Sauce. I love mustard, especially with my fries! Man, I love this place!
Here's a picture of my Rib Eye (done medium rare) topped with a slab of herb butter and served with French fries. I love the steaks here as they're always cooked to perfection with fragrantly seared sides and juicy in the centre. The melted butter adds moisture and flavour to a deliciously tasty steak. The fries are not to be outdone either for they are consistently cooked to perfection. The exterior of the fries are crisp and the interior is fluffy, a perfect French Fry. Apparently the fries here are twice-cooked to achieve this result. I was told some years back that the fries are parboiled first then fried. Fries fans with hearty appetites will be happy to know that you can have unlimited servings of fries. I've not met a person who can go for seconds as we usually are unable to finish the portions on our plates. I'm usually too full after my steak and fries to go for desserts so I cannot comment on the quality of the desserts served here.
This place is definitely a MUST-TRY for steaks and fries!
Forget QE2, Bernanke Says Lookout for QE3
Money is dropping from the sky... catch as much as you can while the window is open...
Forget QE2, Bernanke Says Lookout for QE3
December 6, 2010 7:55 AM EST
Federal ReserveChairman Ben Bernanke said Sunday in an interview with CBS Corp.'s (NYSE: CBS) 60 Minutes that the U.S. economyis barely expanding and that the Fed may need to extend bond purchases past the $600 billion included in QE2 to push growth. Quantitative
“We’re not very far from the level where the economy is not self-sustaining,” Bernanke said. “It’s very close to the border. It takes about 2.5 percent growth just to keep unemployment stable and that’s about what we’re getting.”
The comments from the Fed Chairman come just days after it was announced by the Labor Department that the U.S. economy added just 39,000 jobs in November and that the unemployment rate rose to 9.8 percent, the highest level since April.
“At the rate we’re going, it could be four, five years before we are back to a more normal unemployment rate,” Bernanke said.
He also reiterated that policy in China of limiting gains in its exchange rate is damaging the U.S. economy.
“Keeping the Chinese currency too low is bad for the American economy because it hurts our trade,” the chairman said. “It’s bad for other emerging market economies. It’s bad for China because among other things it means China can’t have its own independent monetary policy.”
Bernanke said that the a double-dip recession is not likely due to sectors of the economy not capable of becoming much more depressed.
Forget QE2, Bernanke Says Lookout for QE3
December 6, 2010 7:55 AM EST
Federal ReserveChairman Ben Bernanke said Sunday in an interview with CBS Corp.'s (NYSE: CBS) 60 Minutes that the U.S. economyis barely expanding and that the Fed may need to extend bond purchases past the $600 billion included in QE2 to push growth. Quantitative
“We’re not very far from the level where the economy is not self-sustaining,” Bernanke said. “It’s very close to the border. It takes about 2.5 percent growth just to keep unemployment stable and that’s about what we’re getting.”
The comments from the Fed Chairman come just days after it was announced by the Labor Department that the U.S. economy added just 39,000 jobs in November and that the unemployment rate rose to 9.8 percent, the highest level since April.
“At the rate we’re going, it could be four, five years before we are back to a more normal unemployment rate,” Bernanke said.
He also reiterated that policy in China of limiting gains in its exchange rate is damaging the U.S. economy.
“Keeping the Chinese currency too low is bad for the American economy because it hurts our trade,” the chairman said. “It’s bad for other emerging market economies. It’s bad for China because among other things it means China can’t have its own independent monetary policy.”
Bernanke said that the a double-dip recession is not likely due to sectors of the economy not capable of becoming much more depressed.
China Outstrips Fed with Liquidity Risking 2011 Inflation Spike
The Chinese government is behind the curve. They have to raise short term rates repeatedly. Right now, 3mths SHIBOR is around 3.5% and 10yr Govt Bond Yield around 3.89%. Their yield curve may actually invert! Now an inverted yield curve usually predicts a recession one-year ahead so I am very cautious on Chinese equities now. The 10y yield is so low probably because of foreign investors pouring money into China in search of currency gains. It could also be a sign of weakening of economy in 2012.
Chinese equities will probably be choppy for the next 6 months before resuming its uptrend while the government embarks on a series of rate hikes to catch up with the curve.
China Outstrips Fed With Liquidity Risking 2011 Inflation Spike
By Bloomberg News - Dec 7, 2010 11:01 AM GMT+0800
Business ExchangeBuzz up!DiggPrint Email . The People’s Bank of China will raise rates “gradually” as a more aggressive policy would risk unsettling the stock and property markets, PBOC adviser Li Daokui said.
Play VideoDec. 6 (Bloomberg) -- Andy Xie, an independent economist, discusses China's economy and monetary policy. Xie speaks from Shanghai with Deirdre Bolton on Bloomberg Television's "InsideTrack." (Source: Bloomberg)
China’s reluctance to allow a stronger exchange rate has hamstrung its efforts to rein in inflation and endangered a campaign to shift the economy toward domestic demand.
The central bank continues to add liquidity, with money supply rising 19 percent in November from a year ago, according to the median estimate of 29 analysts in a Bloomberg News survey before a government release this month. That needs to be curbed to 15 percent to 16 percent to rein in inflation, said Fred Hu, the former Goldman Sachs Group Inc. chief China economist who has founded financial advisory firm Primavera Capital Group.
China has held off executing a series of interest-rate increases in part because that would put pressure on a currency officials have kept down to shelter exports. The strategy will leave inflation accelerating past 4 percent for 2011, a three- year high, according to a separate survey. The cost: diminished consumer spending and narrower margins for domestic industries.
“China is behind the curve” on reining in the monetary measures adopted during the global financial crisis, said Hu, 47, who is based in Beijing and gives talks to Communist Party members on the economy. “Policy makers have been complacent and failed to anticipate the inflationary consequences of the massive stimulus program.”
2011 Forecasts
Economists anticipate a 1 percentage point rise in the benchmark one-year lending and deposit rates by the end of next year, according to the medians of 13 forecasts in the Bloomberg survey taken last week. Gross domestic product will rise 9.2 percent in 2011, the median projection shows, compared with the 10 percent gain estimated by the World Bank for 2010.
The PBOC boosted the rates by a quarter point each in October, to 5.56 percent and 2.5 percent, leaving it lagging behind counterparts from Malaysia to Thailand, Taiwan and South Korea in boosting borrowing costs this year.
Inflation will average 4.2 percent in 2011, the survey indicated, little changed from the two-year high of 4.4 percent reached in October. That would leave a negative so-called real rate for deposits, meaning households’ purchasing power is eroded by the increases in consumer prices.
“This is like adding fuel to the fire,” said Hu, referring to negative real interest rates.
Politburo’s Shift
The Communist Party’s Politburo, meeting Dec. 3, signaled it plans to tighten monetary policy in the coming year while sustaining a fiscal boost to growth. Officials “will adopt proactive fiscal policies and prudent monetary policies,” the state-run Xinhua News Agency said. Policy makers had previously used the term “moderately loose” for the central bank’s stance.
A candidate to succeed Premier Wen Jiabao, Li Keqiang, viewed Chinese GDP figures as unreliable, the Telegraph reported, citing a 2007 diplomatic cable that was published by Wikileaks. Li, then leader in Liaoning province, told the U.S. ambassador at the time that he relied instead on electricity consumption, rail cargo volume and loan disbursement tallies to gauge the local economy, the newspaper reported.
Electricity and new-loan figures have indicated a slowing in China’s expansion this quarter, with electricity-production growth moderating to an 8.9 percent pace in October from 13.4 percent in September, according to China Economic Information Net. Credit growth probably eased to 500 billion yuan in November from 587.7 billion in October, according to the median estimate ahead of a release this month.
Move ‘Gradually’
The People’s Bank of China will raise rates “gradually” as a more aggressive policy would risk unsettling the stock and property markets, PBOC adviser Li Daokui said in a Dec. 3 interview.
While China’s officials have faulted the U.S. Federal Reserve’s plan to purchase $600 billion of Treasury securities for the risk of a wave of capital flooding into emerging markets and pushing up asset prices, there’s little sign yet of a jump in American liquidity.
The U.S. M2 measure rose 3.2 percent in October from a year before. Consumer prices in the U.S., excluding food and fuel, gained 0.6 percent in October from a year before, the least in records going back to 1958 (The US banks are not lending, that's why M2 is not rising. Where did they all go? Out of the country into Emerging Markets/ AXJ stocks and commodities!).
“If anyone is printing money it is China’s central bank, not the U.S.,” said Stephen Green, head of research for Greater China at Standard Chartered Plc. in Shanghai. Actual price increases faced by Chinese consumers and businesses are probably even higher than official reports, and pushing up rates now “is the wisest course of action,” he said.
Equities Strategy
Slowing growth may itself help damp price pressures, along with diminished credit expansion, said Qu Hongbin, co-head of economic research at HSBC Holdings Plc in Hong Kong. Qu sees just one quarter-point move before the PBOC finishes its job for the duration through 2011.
HSBC analysts said last month investors should sell stocks likely to be more affected by a rate rise, such as banks and developers, and instead buy stocks of higher value-added manufacturers such as makers of precision machinery.
Wal-Mart Stores Inc. and Carrefour SA are among the international companies that may be affected as the government threatens price controls in an effort to rein in food inflation that reached 10 percent in October.
Wal-Mart, Carrefour
The southwestern city of Kunming, has asked five retailers including Bentonville, Arkansas-based Wal-Mart and Paris-based Carrefour to give reasons for planned price increases two days in advance of any alterations, the National Development and Reform Commission’s local branch said on its website Dec. 3.
China’s non-manufacturing industry, incorporating services, saw input costs outpace prices charged in November, shrinking profit margins, the Federation of Logistics and Purchasing said last week. Consumer confidence is also weakening, with a sentiment index falling for the first time in six quarters, a survey by Nielsen Co. and the Chinese statistics bureau’s Economic Monitoring and Analysis Center showed last month.
President Hu Jintao’s five-year plan, starting in 2011, is aimed in part at buttressing domestic demand and reducing reliance on exports, which tumbled during the contraction in global trade because of the financial crisis. Domestic consumption has shrunk to about 35 percent of GDP from 45 percent a decade ago, Societe Generale SA has calculated (wow, that's even lower than Singapore's 45%. So like Singaporeans, the country statistically is rich but citizens feel normal).
Trade Tension
Little of such rebalancing is evident in economists’ 2011 forecasts, with China’s trade surplus seen at $183 billion next year, according to the median projection. The surplus was $148 billion in the first 10 months of 2010, fueling charges China’s currency policy provides a subsidy to its exporters. President Barack Obama said last month that “China spends enormous amounts of money” keeping the yuan undervalued. The nation’s foreign-exchange reserves were a record $2.6 trillion in September.
“China can’t have its own independent monetary policy” as long as it manages the exchange rate, Federal Reserve Chairman Ben S. Bernanke said in a excerpts of an interview released by CBS Corp.’s “60 minutes” program Dec. 5.
Authorities have let the yuan rise less than 3 percent against the dollar since allowing greater flexibility in June, with the currency at 6.6488 at 10:55 a.m. in Shanghai. It will reach 6.25 by Dec. 31, 2011, the Bloomberg survey indicates.
Investors should bet on yuan gains through six-month non- deliverable forwards because officials will recognize the need for a stronger currency to fight inflation, said Mitul Kotecha, head of global foreign exchange strategy at Credit Agricole CIB in Hong Kong. Forwards are pricing in a yuan rise to about 6.58 against the dollar in six months. Kotecha estimates the currency will rise to 6.43 by the end of June.
--Kevin Hamlin. With assistance from Jay Wang and Sophie Leung. Editors: Chris Anstey, Paul Panckhurst.
To contact the Bloomberg News staff on this story: Kevin Hamlin in Beijing on khamlin@bloomberg.net
To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net
.
Chinese equities will probably be choppy for the next 6 months before resuming its uptrend while the government embarks on a series of rate hikes to catch up with the curve.
China Outstrips Fed With Liquidity Risking 2011 Inflation Spike
By Bloomberg News - Dec 7, 2010 11:01 AM GMT+0800
Business ExchangeBuzz up!DiggPrint Email . The People’s Bank of China will raise rates “gradually” as a more aggressive policy would risk unsettling the stock and property markets, PBOC adviser Li Daokui said.
Play VideoDec. 6 (Bloomberg) -- Andy Xie, an independent economist, discusses China's economy and monetary policy. Xie speaks from Shanghai with Deirdre Bolton on Bloomberg Television's "InsideTrack." (Source: Bloomberg)
China’s reluctance to allow a stronger exchange rate has hamstrung its efforts to rein in inflation and endangered a campaign to shift the economy toward domestic demand.
The central bank continues to add liquidity, with money supply rising 19 percent in November from a year ago, according to the median estimate of 29 analysts in a Bloomberg News survey before a government release this month. That needs to be curbed to 15 percent to 16 percent to rein in inflation, said Fred Hu, the former Goldman Sachs Group Inc. chief China economist who has founded financial advisory firm Primavera Capital Group.
China has held off executing a series of interest-rate increases in part because that would put pressure on a currency officials have kept down to shelter exports. The strategy will leave inflation accelerating past 4 percent for 2011, a three- year high, according to a separate survey. The cost: diminished consumer spending and narrower margins for domestic industries.
“China is behind the curve” on reining in the monetary measures adopted during the global financial crisis, said Hu, 47, who is based in Beijing and gives talks to Communist Party members on the economy. “Policy makers have been complacent and failed to anticipate the inflationary consequences of the massive stimulus program.”
2011 Forecasts
Economists anticipate a 1 percentage point rise in the benchmark one-year lending and deposit rates by the end of next year, according to the medians of 13 forecasts in the Bloomberg survey taken last week. Gross domestic product will rise 9.2 percent in 2011, the median projection shows, compared with the 10 percent gain estimated by the World Bank for 2010.
The PBOC boosted the rates by a quarter point each in October, to 5.56 percent and 2.5 percent, leaving it lagging behind counterparts from Malaysia to Thailand, Taiwan and South Korea in boosting borrowing costs this year.
Inflation will average 4.2 percent in 2011, the survey indicated, little changed from the two-year high of 4.4 percent reached in October. That would leave a negative so-called real rate for deposits, meaning households’ purchasing power is eroded by the increases in consumer prices.
“This is like adding fuel to the fire,” said Hu, referring to negative real interest rates.
Politburo’s Shift
The Communist Party’s Politburo, meeting Dec. 3, signaled it plans to tighten monetary policy in the coming year while sustaining a fiscal boost to growth. Officials “will adopt proactive fiscal policies and prudent monetary policies,” the state-run Xinhua News Agency said. Policy makers had previously used the term “moderately loose” for the central bank’s stance.
A candidate to succeed Premier Wen Jiabao, Li Keqiang, viewed Chinese GDP figures as unreliable, the Telegraph reported, citing a 2007 diplomatic cable that was published by Wikileaks. Li, then leader in Liaoning province, told the U.S. ambassador at the time that he relied instead on electricity consumption, rail cargo volume and loan disbursement tallies to gauge the local economy, the newspaper reported.
Electricity and new-loan figures have indicated a slowing in China’s expansion this quarter, with electricity-production growth moderating to an 8.9 percent pace in October from 13.4 percent in September, according to China Economic Information Net. Credit growth probably eased to 500 billion yuan in November from 587.7 billion in October, according to the median estimate ahead of a release this month.
Move ‘Gradually’
The People’s Bank of China will raise rates “gradually” as a more aggressive policy would risk unsettling the stock and property markets, PBOC adviser Li Daokui said in a Dec. 3 interview.
While China’s officials have faulted the U.S. Federal Reserve’s plan to purchase $600 billion of Treasury securities for the risk of a wave of capital flooding into emerging markets and pushing up asset prices, there’s little sign yet of a jump in American liquidity.
The U.S. M2 measure rose 3.2 percent in October from a year before. Consumer prices in the U.S., excluding food and fuel, gained 0.6 percent in October from a year before, the least in records going back to 1958 (The US banks are not lending, that's why M2 is not rising. Where did they all go? Out of the country into Emerging Markets/ AXJ stocks and commodities!).
“If anyone is printing money it is China’s central bank, not the U.S.,” said Stephen Green, head of research for Greater China at Standard Chartered Plc. in Shanghai. Actual price increases faced by Chinese consumers and businesses are probably even higher than official reports, and pushing up rates now “is the wisest course of action,” he said.
Equities Strategy
Slowing growth may itself help damp price pressures, along with diminished credit expansion, said Qu Hongbin, co-head of economic research at HSBC Holdings Plc in Hong Kong. Qu sees just one quarter-point move before the PBOC finishes its job for the duration through 2011.
HSBC analysts said last month investors should sell stocks likely to be more affected by a rate rise, such as banks and developers, and instead buy stocks of higher value-added manufacturers such as makers of precision machinery.
Wal-Mart Stores Inc. and Carrefour SA are among the international companies that may be affected as the government threatens price controls in an effort to rein in food inflation that reached 10 percent in October.
Wal-Mart, Carrefour
The southwestern city of Kunming, has asked five retailers including Bentonville, Arkansas-based Wal-Mart and Paris-based Carrefour to give reasons for planned price increases two days in advance of any alterations, the National Development and Reform Commission’s local branch said on its website Dec. 3.
China’s non-manufacturing industry, incorporating services, saw input costs outpace prices charged in November, shrinking profit margins, the Federation of Logistics and Purchasing said last week. Consumer confidence is also weakening, with a sentiment index falling for the first time in six quarters, a survey by Nielsen Co. and the Chinese statistics bureau’s Economic Monitoring and Analysis Center showed last month.
President Hu Jintao’s five-year plan, starting in 2011, is aimed in part at buttressing domestic demand and reducing reliance on exports, which tumbled during the contraction in global trade because of the financial crisis. Domestic consumption has shrunk to about 35 percent of GDP from 45 percent a decade ago, Societe Generale SA has calculated (wow, that's even lower than Singapore's 45%. So like Singaporeans, the country statistically is rich but citizens feel normal).
Trade Tension
Little of such rebalancing is evident in economists’ 2011 forecasts, with China’s trade surplus seen at $183 billion next year, according to the median projection. The surplus was $148 billion in the first 10 months of 2010, fueling charges China’s currency policy provides a subsidy to its exporters. President Barack Obama said last month that “China spends enormous amounts of money” keeping the yuan undervalued. The nation’s foreign-exchange reserves were a record $2.6 trillion in September.
“China can’t have its own independent monetary policy” as long as it manages the exchange rate, Federal Reserve Chairman Ben S. Bernanke said in a excerpts of an interview released by CBS Corp.’s “60 minutes” program Dec. 5.
Authorities have let the yuan rise less than 3 percent against the dollar since allowing greater flexibility in June, with the currency at 6.6488 at 10:55 a.m. in Shanghai. It will reach 6.25 by Dec. 31, 2011, the Bloomberg survey indicates.
Investors should bet on yuan gains through six-month non- deliverable forwards because officials will recognize the need for a stronger currency to fight inflation, said Mitul Kotecha, head of global foreign exchange strategy at Credit Agricole CIB in Hong Kong. Forwards are pricing in a yuan rise to about 6.58 against the dollar in six months. Kotecha estimates the currency will rise to 6.43 by the end of June.
--Kevin Hamlin. With assistance from Jay Wang and Sophie Leung. Editors: Chris Anstey, Paul Panckhurst.
To contact the Bloomberg News staff on this story: Kevin Hamlin in Beijing on khamlin@bloomberg.net
To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net
.
Euro's Worst Ahead as Analyst See Crisis Spreading
Imagine if you belong to this society where you own 30% of it. The society said that they will give you free money, on condition that it is all used to lend money to other members that will pay you very low interest rates. You're not even sure if you'll be paid back at maturity. All you know is the society will keep issuing new bonds, making you buy those bonds to pay back those that have matured. In other words, you're given free money, but chances are, you won't get it for another decade or more.
Since it's free, you'd probably be ok with it. As long as inflation in your own backyard doesn't go up. After all, if the society prints more money, it will devalue your currency and your exporters benefit. Politically, you'll be popular. More jobs will be created.
But at some point, inflation is likely to rise. Maybe end of next year, maybe in 2012. If you accept that "free money" again, you know you'll face a revolt back home because workers will ask for massive wage rises. Once inflation is above 4%, it sets up a vicious cycle and is very hard to tame. Will you accept that free money?
The little PIIGS + Belgium better learn to balance their books while Germany / France / UK can tolerate this. Because if inflation spikes up in these 3 countries, they will say "no thanks". That's where the trouble starts.
But wait, there're greater problems ahead. In order to balance their books, they have to raise taxes and cut spending. There may be political instability. Spanish air traffic controllers paid USD450k per annum? Ridiculous. In Singapore, the same worker with the same experience gets paid USD75k if they are lucky. Now you know why OECD hates globalisation. Because the same worker from Singapore, India, China can work harder and be paid 4x less. Globalisation will mean an abrupt end to the Europeans' lifestyle as they know it. Either way, this equalisation will happen. Already Polish plumbers/builders in UK are bringing down the wages of UK plumbers/builders.
PIIGS + Belgium will plunge into a very deep recession for the next 2 - 3 years, even up to 5 years due to their race to balance their books. Real wages will fall. Time to visit Europe and the US next year!
Bloomberg News
Euro’s Worst Ahead as Analysts See Crisis Spreading
Dec. 6 (Bloomberg) -- The most accurate foreign-exchange strategists say the euro’s worst annual performance since 2005 will extend into next year as the region’s sovereign-debt crisis saps economic growth.
Standard Chartered Plc, the top overall forecaster in the six quarters ended Sept. 30 based on data compiled by Bloomberg, predicted the euro may weaken to less than $1.20 by mid-2011 from about $1.33 today. Westpac Banking Corp., the second most accurate, is “bearish in the short term,” and No. 3 Wells Fargo & Co. cut its outlook at the end of last week.
The 16-nation currency’s first weekly gain against the dollar since Nov. 5 may prove short-lived amid mounting concern that more nations will need rescues. European Central Bank President Jean-Claude Trichet delayed the end of emergency stimulus measures last week and stepped up government-debt purchases as “acute” market tensions drove yields on Spanish and Italian bonds to the highest levels relative to German bunds since the euro started in 1999.
“We’re going to get a continuation of the problems that Ireland, Portugal, Spain and others are suffering,” said Callum Henderson, Standard Chartered’s global head of foreign-exchange research in Singapore. “The fundamental issue is these are countries that have relatively large debts, large budget deficits, large current-account deficits, they don’t have their own currency and they can’t cut interest rates. The only way they can get out of this is to have significant recessions.”
Sentiment Reverses
Ireland’s budget deficit will rise to more than 32 percent of gross domestic product this year, including the cost of bailing out the nation’s banks, European Commission data from Nov. 29 showed. Spain’s deficit will be 9.3 percent in 2010. Portugal’s total debt will reach almost 83 percent of GDP this year from about 76 percent in 2009, according to the commission.
Just a month ago the euro reached $1.4282, the strongest level since January, as traders sold the dollar on speculation the Federal Reserve would debase the greenback by printing more cash to purchase $600 billion of Treasuries in so-called quantitative easing.
Now, those concerns are being overshadowed by the possibility that Europe’s economy slows next year as governments impose austerity measures to reduce budget deficits, while officials drive bond investors away with talk of forcing them to take losses as part of future bailouts (would you buy the bonds if there isn't a 100% backstop guarantee by ECB??? Makes things worse).
Risk Reversals
Demand for options granting the right to sell the euro over the next three months relative to those allowing for purchases reached the highest level since June last week. The so-called 25-delta risk reversal rate fell to negative 2.5225 percentage points from negative 0.5725 in October.
European banks paid the biggest premium to borrow in dollars through the swaps market since May last week, a signal the outlook for the euro may deteriorate. The price of two-year cross-currency basis swaps between euros and dollars reached minus 51.8 basis points on Dec. 1, from minus 20.9 on Nov. 4.
“We have a lot of time to go” before the situation in Europe is resolved, John Taylor chairman of FX Concepts LLC, the world’s biggest currency hedge fund, said Dec. 2 at the Hedge Funds New York Conference hosted by Bloomberg Link. “That means the market is going to be twitching.”
Taylor predicted some nations may leave the common currency. Stronger members “have to say ‘enough, you guys, get out of the euro,’” he said. “The risk that Spain and Italy will get into trouble is going to cause the euro to get quite weak.”
The region’s economy may expand 1.4 percent next year, compared with 2.5 percent in the U.S., according to the median estimate of more than 20 economists in Bloomberg surveys.
Market ‘Tensions’
“Uncertainty is elevated,” Trichet told reporters after the ECB left its benchmark interest rate at 1 percent on Dec. 2. “We have tensions and we have to take them into account.”
The ECB will keep offering banks as much cash as they want through the first quarter over periods of as long as three months at a fixed interest rate, Trichet said. That marks a shift from last month, when he said that the ECB could start limiting access to its funds.
The euro declined 0.9 percent against the dollar to $1.3294 as of 12:51 p.m. in New York. While the euro rose 1.3 percent against the dollar last week, it’s down 6.4 percent from Nov. 4. For the year, it has fallen 7.2 percent, following a gain of 2.51 percent in 2009.
Westpac predicts the euro may weaken to $1.2650-$1.2670 in one month, said Lauren Rosborough, a senior strategist in London. The bank then expects the Fed’s bond-purchase plan to weigh on the dollar, according to Robert Rennie, head of currency research at Westpac in Sydney.
‘Source of Negativity’
“As we progress through next year, we see quantitative easing in the U.S. as an ongoing source of negativity for the U.S. dollar,” Rennie said. “We’ve got the euro up to $1.35 by March and $1.38 by June.”
Federal Reserve Chairman Ben S. Bernanke said yesterday the economy is barely expanding at a sustainable pace and that it’s possible the Fed may expand bond purchases beyond the $600 billion announced last month to spur growth.
Unlike the Fed, the ECB isn’t conducting quantitative easing. That helped keep the euro from matching this year’s low of $1.1877 reached on June 7.
Outside of the most accurate forecasters, strategists are hesitant to reduce their estimates. Even as the euro slumped 6.9 percent last month, the median mid-2011 estimate of 41 strategists surveyed by Bloomberg rose to $1.36 from $1.35.
Trichet’s Signal
Germany is making up for some of the weakness in the economies of Greece, Ireland, Portugal and Spain. Last week the Nuremberg-based Federal Labor Agency said the number of Germans out of work declined a seasonally adjusted 9,000 to 3.14 million, the lowest level since December 1992. German business confidence surged to a record in November as domestic spending increased, the Ifo institute in Munich said on Nov. 24.
Trichet signaled on Nov. 30 that investors are underestimating policy makers’ determination to shore up the region’s stability. He said in Paris on Dec. 3 that euro-area governments need a “quasi” fiscal union (See, I told you so).
“There will be sufficient political will to find measures that will bind the system together,” said Jane Foley, a London- based senior currency strategist at Rabobank International, one of the most bullish on the euro among the most accurate forecasters. “The euro will come out of this stronger.”
Foley said the euro will strengthen to $1.40 in the first quarter and to $1.45 by the end of June.
Traders are anticipating more declines as the U.S. economy picks up speed.
Diverging Economies
The U.S. created jobs in November for a second month, data from the Labor Department in Washington showed Dec. 3. Two days earlier, the Institute for Supply Management’s factory index showed manufacturing expanded for a 16th month. By contrast, growth in Europe’s GDP slowed to 0.4 percent in the third quarter from 1 percent in the three months ended June 30, according to EU figures on Dec. 2.
As the euro region’s most-indebted nations cut spending to bring their deficits under control, a weaker euro will be needed to cushion their economies, said Ian Stannard, a senior currency strategist in London at BNP Paribas SA, the fifth most accurate forecaster. The bank says the euro will trade at $1.25 by the end of June and $1.20 in the third quarter.
Declines in the bonds of euro-region members including Ireland and Spain have accelerated after EU leaders agreed on Oct. 29 to consider German Chancellor Angela Merkel’s proposal to force bondholders to share the cost of future bailouts.
Wells Cuts
The crisis prompted Wells Fargo to lower its first-quarter target for the euro to $1.37-$1.38 from a November forecast of $1.41, said Nick Bennenbroek, head of foreign-exchange strategy in New York. He sees the currency at $1.25 by late next year.
The debt crisis “will remain with us for longer, which is why we lowered our targets,” he said. “The move in the euro has been particularly rapid and you can say the currency markets have been panic driven, so we feel like it’s overdone. We do expect the euro to fall over time but we expect the decline to be more orderly than has been the case recently.”
Companies participating in the ranking were compared based on seven criteria: six forecasts at the end of each quarter for the close of the next, starting in March 2009, plus one annual estimate, which was made at the end of September 2009 for currency rates as of Sept. 30, 2010.
Only firms with at least four forecasts for a particular currency pair were ranked for it, and only those that qualified in at least five of eight pairs were included in the ranking of best overall predictors.
To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net
To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net
Since it's free, you'd probably be ok with it. As long as inflation in your own backyard doesn't go up. After all, if the society prints more money, it will devalue your currency and your exporters benefit. Politically, you'll be popular. More jobs will be created.
But at some point, inflation is likely to rise. Maybe end of next year, maybe in 2012. If you accept that "free money" again, you know you'll face a revolt back home because workers will ask for massive wage rises. Once inflation is above 4%, it sets up a vicious cycle and is very hard to tame. Will you accept that free money?
The little PIIGS + Belgium better learn to balance their books while Germany / France / UK can tolerate this. Because if inflation spikes up in these 3 countries, they will say "no thanks". That's where the trouble starts.
But wait, there're greater problems ahead. In order to balance their books, they have to raise taxes and cut spending. There may be political instability. Spanish air traffic controllers paid USD450k per annum? Ridiculous. In Singapore, the same worker with the same experience gets paid USD75k if they are lucky. Now you know why OECD hates globalisation. Because the same worker from Singapore, India, China can work harder and be paid 4x less. Globalisation will mean an abrupt end to the Europeans' lifestyle as they know it. Either way, this equalisation will happen. Already Polish plumbers/builders in UK are bringing down the wages of UK plumbers/builders.
PIIGS + Belgium will plunge into a very deep recession for the next 2 - 3 years, even up to 5 years due to their race to balance their books. Real wages will fall. Time to visit Europe and the US next year!
Bloomberg News
Euro’s Worst Ahead as Analysts See Crisis Spreading
Dec. 6 (Bloomberg) -- The most accurate foreign-exchange strategists say the euro’s worst annual performance since 2005 will extend into next year as the region’s sovereign-debt crisis saps economic growth.
Standard Chartered Plc, the top overall forecaster in the six quarters ended Sept. 30 based on data compiled by Bloomberg, predicted the euro may weaken to less than $1.20 by mid-2011 from about $1.33 today. Westpac Banking Corp., the second most accurate, is “bearish in the short term,” and No. 3 Wells Fargo & Co. cut its outlook at the end of last week.
The 16-nation currency’s first weekly gain against the dollar since Nov. 5 may prove short-lived amid mounting concern that more nations will need rescues. European Central Bank President Jean-Claude Trichet delayed the end of emergency stimulus measures last week and stepped up government-debt purchases as “acute” market tensions drove yields on Spanish and Italian bonds to the highest levels relative to German bunds since the euro started in 1999.
“We’re going to get a continuation of the problems that Ireland, Portugal, Spain and others are suffering,” said Callum Henderson, Standard Chartered’s global head of foreign-exchange research in Singapore. “The fundamental issue is these are countries that have relatively large debts, large budget deficits, large current-account deficits, they don’t have their own currency and they can’t cut interest rates. The only way they can get out of this is to have significant recessions.”
Sentiment Reverses
Ireland’s budget deficit will rise to more than 32 percent of gross domestic product this year, including the cost of bailing out the nation’s banks, European Commission data from Nov. 29 showed. Spain’s deficit will be 9.3 percent in 2010. Portugal’s total debt will reach almost 83 percent of GDP this year from about 76 percent in 2009, according to the commission.
Just a month ago the euro reached $1.4282, the strongest level since January, as traders sold the dollar on speculation the Federal Reserve would debase the greenback by printing more cash to purchase $600 billion of Treasuries in so-called quantitative easing.
Now, those concerns are being overshadowed by the possibility that Europe’s economy slows next year as governments impose austerity measures to reduce budget deficits, while officials drive bond investors away with talk of forcing them to take losses as part of future bailouts (would you buy the bonds if there isn't a 100% backstop guarantee by ECB??? Makes things worse).
Risk Reversals
Demand for options granting the right to sell the euro over the next three months relative to those allowing for purchases reached the highest level since June last week. The so-called 25-delta risk reversal rate fell to negative 2.5225 percentage points from negative 0.5725 in October.
European banks paid the biggest premium to borrow in dollars through the swaps market since May last week, a signal the outlook for the euro may deteriorate. The price of two-year cross-currency basis swaps between euros and dollars reached minus 51.8 basis points on Dec. 1, from minus 20.9 on Nov. 4.
“We have a lot of time to go” before the situation in Europe is resolved, John Taylor chairman of FX Concepts LLC, the world’s biggest currency hedge fund, said Dec. 2 at the Hedge Funds New York Conference hosted by Bloomberg Link. “That means the market is going to be twitching.”
Taylor predicted some nations may leave the common currency. Stronger members “have to say ‘enough, you guys, get out of the euro,’” he said. “The risk that Spain and Italy will get into trouble is going to cause the euro to get quite weak.”
The region’s economy may expand 1.4 percent next year, compared with 2.5 percent in the U.S., according to the median estimate of more than 20 economists in Bloomberg surveys.
Market ‘Tensions’
“Uncertainty is elevated,” Trichet told reporters after the ECB left its benchmark interest rate at 1 percent on Dec. 2. “We have tensions and we have to take them into account.”
The ECB will keep offering banks as much cash as they want through the first quarter over periods of as long as three months at a fixed interest rate, Trichet said. That marks a shift from last month, when he said that the ECB could start limiting access to its funds.
The euro declined 0.9 percent against the dollar to $1.3294 as of 12:51 p.m. in New York. While the euro rose 1.3 percent against the dollar last week, it’s down 6.4 percent from Nov. 4. For the year, it has fallen 7.2 percent, following a gain of 2.51 percent in 2009.
Westpac predicts the euro may weaken to $1.2650-$1.2670 in one month, said Lauren Rosborough, a senior strategist in London. The bank then expects the Fed’s bond-purchase plan to weigh on the dollar, according to Robert Rennie, head of currency research at Westpac in Sydney.
‘Source of Negativity’
“As we progress through next year, we see quantitative easing in the U.S. as an ongoing source of negativity for the U.S. dollar,” Rennie said. “We’ve got the euro up to $1.35 by March and $1.38 by June.”
Federal Reserve Chairman Ben S. Bernanke said yesterday the economy is barely expanding at a sustainable pace and that it’s possible the Fed may expand bond purchases beyond the $600 billion announced last month to spur growth.
Unlike the Fed, the ECB isn’t conducting quantitative easing. That helped keep the euro from matching this year’s low of $1.1877 reached on June 7.
Outside of the most accurate forecasters, strategists are hesitant to reduce their estimates. Even as the euro slumped 6.9 percent last month, the median mid-2011 estimate of 41 strategists surveyed by Bloomberg rose to $1.36 from $1.35.
Trichet’s Signal
Germany is making up for some of the weakness in the economies of Greece, Ireland, Portugal and Spain. Last week the Nuremberg-based Federal Labor Agency said the number of Germans out of work declined a seasonally adjusted 9,000 to 3.14 million, the lowest level since December 1992. German business confidence surged to a record in November as domestic spending increased, the Ifo institute in Munich said on Nov. 24.
Trichet signaled on Nov. 30 that investors are underestimating policy makers’ determination to shore up the region’s stability. He said in Paris on Dec. 3 that euro-area governments need a “quasi” fiscal union (See, I told you so).
“There will be sufficient political will to find measures that will bind the system together,” said Jane Foley, a London- based senior currency strategist at Rabobank International, one of the most bullish on the euro among the most accurate forecasters. “The euro will come out of this stronger.”
Foley said the euro will strengthen to $1.40 in the first quarter and to $1.45 by the end of June.
Traders are anticipating more declines as the U.S. economy picks up speed.
Diverging Economies
The U.S. created jobs in November for a second month, data from the Labor Department in Washington showed Dec. 3. Two days earlier, the Institute for Supply Management’s factory index showed manufacturing expanded for a 16th month. By contrast, growth in Europe’s GDP slowed to 0.4 percent in the third quarter from 1 percent in the three months ended June 30, according to EU figures on Dec. 2.
As the euro region’s most-indebted nations cut spending to bring their deficits under control, a weaker euro will be needed to cushion their economies, said Ian Stannard, a senior currency strategist in London at BNP Paribas SA, the fifth most accurate forecaster. The bank says the euro will trade at $1.25 by the end of June and $1.20 in the third quarter.
Declines in the bonds of euro-region members including Ireland and Spain have accelerated after EU leaders agreed on Oct. 29 to consider German Chancellor Angela Merkel’s proposal to force bondholders to share the cost of future bailouts.
Wells Cuts
The crisis prompted Wells Fargo to lower its first-quarter target for the euro to $1.37-$1.38 from a November forecast of $1.41, said Nick Bennenbroek, head of foreign-exchange strategy in New York. He sees the currency at $1.25 by late next year.
The debt crisis “will remain with us for longer, which is why we lowered our targets,” he said. “The move in the euro has been particularly rapid and you can say the currency markets have been panic driven, so we feel like it’s overdone. We do expect the euro to fall over time but we expect the decline to be more orderly than has been the case recently.”
Companies participating in the ranking were compared based on seven criteria: six forecasts at the end of each quarter for the close of the next, starting in March 2009, plus one annual estimate, which was made at the end of September 2009 for currency rates as of Sept. 30, 2010.
Only firms with at least four forecasts for a particular currency pair were ranked for it, and only those that qualified in at least five of eight pairs were included in the ranking of best overall predictors.
To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net
To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net
Monday, 6 December 2010
My Thoughts
Most of the capital controles in emerging markets are implemented on fixed income and property, not stocks. There's a reason for this; if countries allow foreign funds to buy up bonds, yields will fall to floor levels. Currency will shoot up. This will fuel borrowing in the country and drive up inflation.
Property for obvious reasons is tightly controlled. The social implications are immense.
Stocks are mostly left alone because they have very little leverage to start with. They don't drive down interest rates and fuel wanton borrowing. There is little social risks.
We should go for the commodity exporting countries, Brazil, Russia, Venezuela, Peru, Mongolia. THey are the end destination of all moneys.
I'm apprehensive about China. First, their yield curve is now inverted. Second, their property bubble and banking system is a big question. Third, from nett exporter of coal / metals, they are now nett importers. Their manufacturers' margins will thin.
India doesn't have China's bubble problems. But they are net importers of commodities. INdia's valuations at 20x is far more expensive vs China's 14x.
I will go for Fidelity Emerging Europe Middle East & Africa, Fortis Russia, Amundi Latin America to ride on this trend in 2011. I suspect 2011 will be a much better year than 2010, but not as good as 2009. Usually stocks perform well one year, and badly the next. 2009 was a good trending year. 2010 saw big corrections and half the year was in consolidation.
2011 might see the resumption of the final push to new highs before inflation come back at end of 2011.
I will focus fiercely on BlackRock World Mining / World Gold / World Energy. First State Global Resource is acceptable.
I would avoid Chinese mining stocks due to price controls.
Property for obvious reasons is tightly controlled. The social implications are immense.
Stocks are mostly left alone because they have very little leverage to start with. They don't drive down interest rates and fuel wanton borrowing. There is little social risks.
We should go for the commodity exporting countries, Brazil, Russia, Venezuela, Peru, Mongolia. THey are the end destination of all moneys.
I'm apprehensive about China. First, their yield curve is now inverted. Second, their property bubble and banking system is a big question. Third, from nett exporter of coal / metals, they are now nett importers. Their manufacturers' margins will thin.
India doesn't have China's bubble problems. But they are net importers of commodities. INdia's valuations at 20x is far more expensive vs China's 14x.
I will go for Fidelity Emerging Europe Middle East & Africa, Fortis Russia, Amundi Latin America to ride on this trend in 2011. I suspect 2011 will be a much better year than 2010, but not as good as 2009. Usually stocks perform well one year, and badly the next. 2009 was a good trending year. 2010 saw big corrections and half the year was in consolidation.
2011 might see the resumption of the final push to new highs before inflation come back at end of 2011.
I will focus fiercely on BlackRock World Mining / World Gold / World Energy. First State Global Resource is acceptable.
I would avoid Chinese mining stocks due to price controls.
China's Coal Prices Fall for First Time in 3 Months on Stockpiling Surge
This is why I am slowly shifting to non-Chinese mining companies; the price controls.
China's Coal Prices Fall for First Time in 3 Months on Stockpiling Surge
By Bloomberg News - Dec 6, 2010 12:32 PM GMT+0800
Power-station coal prices at Qinhuangdao port, a Chinese benchmark, fell for the first time in three months after stockpiles of the fuel surged and the government called for stability in the cost of commodities.
Coal with an energy value of 5,500 kilocalories per kilogram slipped 0.6 percent from a week earlier to between 795 yuan ($120) and 810 yuan a metric ton today, according to data from the China Coal Transport and Distribution Association. That’s the first decline since Sept. 8.
Power stations have been building inventories since early September to meet winter heating demand, while the official Xinhua News Agency said in August that the nation was expected to experience abnormally low temperatures this year because of the La Nina weather pattern. Coal stockpiles at Qinhuangdao jumped 15 percent from a week ago to 6.73 million tons, according to the China Coal Transport and Distribution Association today.
“Coal demand hasn’t risen as much as expected so the winter stockpiling seems a bit overdone,” David Fang, a director at the association, said by telephone from Beijing. “Demand remained weak because of government measures to meet energy conservation goals, and there were no surprises in the weather.”
China aims to reduce energy use per unit of GDP by 20 percent in the five years ending this month and has taken steps to curb consumption, including shutting factories. Energy intensity fell about 3 percent in the first nine months, Zhao Jiarong, a deputy secretary general at the National Development and Reform Commission, said in a speech posted on the NDRC’s website today.
Price Stability
The coal-price decline at Qinhuangdao follows calls by the government to ensure price stability, after inflation rose to the highest in more than two years in October.
Power-station coal prices under term contracts for 2011 must be unchanged from 2010 levels, Xinhua reported on Dec. 1, citing Cao Changqing, head of pricing at the NDRC.
“The contract-price freeze will affect sentiment on spot prices,” Fang from the China Coal Transport and Distribution Association said. “It’s hard for spot prices to go higher if contract prices are to remain at this level.”
To contact the reporter on this story: Baizhen Chua in Beijing at bchua14@bloomberg.net
To contact the editor responsible for this story: Clyde Russell at crussell7@bloomberg.net
.
China's Coal Prices Fall for First Time in 3 Months on Stockpiling Surge
By Bloomberg News - Dec 6, 2010 12:32 PM GMT+0800
Power-station coal prices at Qinhuangdao port, a Chinese benchmark, fell for the first time in three months after stockpiles of the fuel surged and the government called for stability in the cost of commodities.
Coal with an energy value of 5,500 kilocalories per kilogram slipped 0.6 percent from a week earlier to between 795 yuan ($120) and 810 yuan a metric ton today, according to data from the China Coal Transport and Distribution Association. That’s the first decline since Sept. 8.
Power stations have been building inventories since early September to meet winter heating demand, while the official Xinhua News Agency said in August that the nation was expected to experience abnormally low temperatures this year because of the La Nina weather pattern. Coal stockpiles at Qinhuangdao jumped 15 percent from a week ago to 6.73 million tons, according to the China Coal Transport and Distribution Association today.
“Coal demand hasn’t risen as much as expected so the winter stockpiling seems a bit overdone,” David Fang, a director at the association, said by telephone from Beijing. “Demand remained weak because of government measures to meet energy conservation goals, and there were no surprises in the weather.”
China aims to reduce energy use per unit of GDP by 20 percent in the five years ending this month and has taken steps to curb consumption, including shutting factories. Energy intensity fell about 3 percent in the first nine months, Zhao Jiarong, a deputy secretary general at the National Development and Reform Commission, said in a speech posted on the NDRC’s website today.
Price Stability
The coal-price decline at Qinhuangdao follows calls by the government to ensure price stability, after inflation rose to the highest in more than two years in October.
Power-station coal prices under term contracts for 2011 must be unchanged from 2010 levels, Xinhua reported on Dec. 1, citing Cao Changqing, head of pricing at the NDRC.
“The contract-price freeze will affect sentiment on spot prices,” Fang from the China Coal Transport and Distribution Association said. “It’s hard for spot prices to go higher if contract prices are to remain at this level.”
To contact the reporter on this story: Baizhen Chua in Beijing at bchua14@bloomberg.net
To contact the editor responsible for this story: Clyde Russell at crussell7@bloomberg.net
.
Tuesday, 30 November 2010
How Does War Affect Stock Markets?
The second Gulf War started on 20 Mar 2003. That was again the start of the last bull run that began from 2003 and ended late 2007.
So war actually boosts stock markets world wide. It boosts defence spending, infrastructure spending and liquidity to calm markets.
Friday, 26 November 2010
This Correction May Last A Bit Longer Till Early to Mid December
Since last week, credit spreads have been creeping up. Although the level is not as high as in May 2010, it is still a cause for concern. There is a danger that the Irish debt and potential war in the Korean Peninsular have caused investors to shun risk assets recently.
On the plus side, money supply indicators are sideways, not deteriorating.
All these point towards a correction to the tune of 10 - 20%. So far, most markets have already corrected 7 - 8%. There could be another 3 - 12% more to go. Volume is down even when markets are down, which is good.
What should you do? Maintain an asset allocation of 60% equities and 40% others/alternatives. Trim off some unwanted equity positions (e.g. if the stock isn't performing even in good times, or is finally turning a profit). Add some volatility funds / short some indices to hedge partially.
Next week, you should start to nibble some stocks very soon. If you're unsure, think about the QE that's happening now. The money's gotta go somewhere.
On the plus side, money supply indicators are sideways, not deteriorating.
All these point towards a correction to the tune of 10 - 20%. So far, most markets have already corrected 7 - 8%. There could be another 3 - 12% more to go. Volume is down even when markets are down, which is good.
What should you do? Maintain an asset allocation of 60% equities and 40% others/alternatives. Trim off some unwanted equity positions (e.g. if the stock isn't performing even in good times, or is finally turning a profit). Add some volatility funds / short some indices to hedge partially.
Next week, you should start to nibble some stocks very soon. If you're unsure, think about the QE that's happening now. The money's gotta go somewhere.
Tuesday, 23 November 2010
The Probable Demise of European Union
20 years ago, the EU members had the chance to resolve the issue, but they skirted around it. They joined a union where labour is free-flowing. They gave up their own currencies, and gave up their domestic monetary policy. But the elephant in the room was fiscal policy. It was the last thing that gave each country its sovereignty. Hence they chose to give broad guidelines to fiscal deficits and relied on "trust".
Today, the skeletons are out. Certain countries haven't been naughty nor nice. They had huge deficits that the more conservative members had to pay.
Is this fair? It depends on how much they want the EU to work. To survive, the EU will need to become a political union, with the ECB or an EU government deciding on how much each country can spend, and taxes to be centrally pooled. However, such an integration will mean giving up the last bastion of sovereignty. Hence, I believe the EU may disintegrate or at least cease to have a single currency. It will merely be a group of countries with free trade agreements.
Today, the skeletons are out. Certain countries haven't been naughty nor nice. They had huge deficits that the more conservative members had to pay.
Is this fair? It depends on how much they want the EU to work. To survive, the EU will need to become a political union, with the ECB or an EU government deciding on how much each country can spend, and taxes to be centrally pooled. However, such an integration will mean giving up the last bastion of sovereignty. Hence, I believe the EU may disintegrate or at least cease to have a single currency. It will merely be a group of countries with free trade agreements.
Monday, 22 November 2010
Sunday, 21 November 2010
Leveraged Long/Short Portfolio
There are certain points where shorting is implemented. This is necessary because a leveraged portfolio can turn to zero in a bear market.
The results are above. The dynamic method works best. The devil is in the details. Another Eureka moment.
What's Really Behind QE2?
What’s Really Behind QE2?
by: Ellen Brown November 19, 2010 Font Size: PrintEmail Recommend 4 Share this page
The deficit hawks are circling, hovering over QE2, calling it just another inflationary bank bailout. But unlike QE1, QE2 is not about saving the banks. It’s about funding the federal deficit without increasing the interest tab, something that may be necessary in this gridlocked political climate just to keep the government functioning.
On November 15, the Wall Street Journal published an open letter to Fed Chairman Ben Bernanke from 23 noted economists, professors and fund managers, urging him to abandon his new “quantitative easing” policy called QE2. The letter said:
We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. . . . The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.
The Pragmatic Capitalist (Cullen Roche) remarked:
Many of the people on this list have been warning about bond vigilantes while also comparing the USA to Greece for several years now. Of course, they’ve been terribly wrong and it is entirely due to the fact that they do not understand how the US monetary system works. . . . What’s unfortunate is that these are many of our best minds. These are the people driving the economic bus.
The deficit hawks say QE is massively inflationary; that it is responsible for soaring commodity prices here and abroad; that QE2 won’t work any better than an earlier scheme called QE1, which was less about stimulating the economy than about saving the banks; and that QE has caused the devaluation of the dollar, which is hurting foreign currencies and driving up prices abroad.
None of these contentions is true, as will be shown. They arise from a failure either to understand modern monetary mechanics (see links at The Pragmatic Capitalist and here) or to understand QE2, which is a different animal from QE1. QE2 is not about saving the banks, or devaluing the dollar, or saving the housing market. It is about saving the government from having to raise taxes or cut programs, and saving Americans from the austerity measures crippling the Irish and the Greeks; and for that, it may well be the most effective tool currently available. QE2 promotes employment by keeping the government in business. The government can then work on adding jobs.
The Looming Threat of a Crippling Debt Service
The federal debt has increased by more than 50% since 2006, due to a collapsed economy and the highly controversial decision to bail out the banks. By the end of 2009, the debt was up to $12.3 trillion; but the interest paid on it ($383 billion) was actually less than in 2006 ($406 billion), because interest rates had been pushed to extremely low levels. Interest now eats up nearly half the government’s income tax receipts, which are estimated at $899 billion for FY 2010. Of this, $414 billion will go to interest on the federal debt. If interest rates were to rise just a couple of percentage points, servicing the federal debt would consume over 100% of current income tax receipts, and taxes might have to be doubled.
As for the surging commodity and currency prices abroad, they are not the result of QE. They are largely the result of the U.S. dollar carry trade, which is the result of pressure to keep interest rates artificially low. Banks that can borrow at the very low fed funds rate (now 0.2%) can turn around and speculate abroad, reaping much higher returns.
Interest rates cannot be raised again to reasonable levels until the cost of servicing the federal debt is reduced; and today that can be done most expeditiously through QE2 -- “monetizing” the debt through the Federal Reserve, essentially interest-free. Alone among the government’s creditors, the Fed rebates the interest to the government after deducting its costs. In 2008, the Fed reported that it rebated 85% of its profits to the government. The interest rate on the 10-year government bonds the Fed is planning to buy is now 2.66%. Fifteen percent of 2.66% is the equivalent of a 0.4% interest rate, the best deal in town on long-term bonds.
A Reluctant Fed Steps Up to the Plate
The Fed was strong-armed into rebating its profits to the government in the 1960s, when Wright Patman, Chairman of the House Banking and Currency Committee, pushed to have the Fed nationalized. According to Congressman Jerry Voorhis in The Strange Case of Richard Milhous Nixon (1973):
As a direct result of logical and relentless agitation by members of Congress, led by Congressman Wright Patman as well as by other competent monetary experts, the Federal Reserve began to pay to the U.S. Treasury a considerable part of its earnings from interest on government securities. This was done without public notice and few people, even today, know that it is being done. It was done, quite obviously, as acknowledgment that the Federal Reserve Banks were acting on the one hand as a national bank of issue, creating the nation’s money, but on the other hand charging the nation interest on its own credit – which no true national bank of issue could conceivably, or with any show of justice, dare to do.
Voorhis went on, “But this is only part of the story. And the less discouraging part, at that. For where the commercial banks are concerned, there is no such repayment of the people’s money.” Commercial banks do not rebate the interest, said Voorhis, although they also “‘buy’ the bonds with newly created demand deposit entries on their books – nothing more.”
After the 1960s, the policy was to fund government bonds through commercial banks (which could collect interest) rather than through the central bank (which could not). This was true not just in the U.S. but in other countries, after a quadrupling of oil prices combined with abandonment of the gold standard produced “stagflation” that was erroneously blamed on governments “printing money.”
Consistent with that longstanding policy, Chairman Bernanke initially resisted funding the federal deficit. In January 2010, he admonished Congress:
We're not going to monetize the debt. It is very, very important for Congress and administration to come to some kind of program, some kind of plan that will credibly show how the United States government is going to bring itself back to a sustainable position.
His concern, according to The Washington Times, was that “the impasse in Congress over tough spending cuts and tax increases needed to bring down deficits will eventually force the Fed to accommodate deficits by printing money and buying Treasury bonds.”
That impasse crystallized on November 3, 2010, when Republicans swept the House. There would be no raising of taxes on the rich, and the gridlock in Congress meant there would be no budget cuts either. Compounding the problem was that over the last six months, China has stopped buying U.S. debt, reducing inflows by about $50 billion per month.
QE2 Is Not QE1
In QE1, the Fed bought $1.2 trillion in toxic mortgage-backed securities off the books of the banks. QE1 mirrored TARP, the government’s Troubled Asset Relief Program, except that TARP was funded by the government with $700 billion in taxpayer money. QE1 was funded by the Federal Reserve with computer keystrokes, simply by crediting the banks’ reserve accounts at the Fed.
Pundits were predicting that QE2 would be more of the same, but it turned out to be something quite different. Immediately after the election, Bernanke announced that the Fed would be using its power to purchase assets to buy federal securities on the secondary market -- from banks, bond investors and hedge funds. (In the EU, the European Central Bank began a similar policy when it bought Greek bonds on the secondary market.) The bond dealers would then be likely to use the money to buy more Treasuries, increasing overall Treasury sales.
The bankers who applauded QE1 were generally critical of QE2, probably because they would get nothing out of it. They would have to give up their interest-bearing bonds for additional cash reserves, something they already have more of than they can use. Unlike QE1, QE2 was designed, not to help the banks, but to relieve the pressure on the federal budget.
Bernanke said the Fed would buy $600 billion in long-term government bonds at the rate of $75 billion per month, filling the hole left by China. An estimated $275 billion would also be rolled over into Treasuries from the mortgage-backed securities the Fed bought during QE1, which are now reaching maturity. More QE was possible, he said, if unemployment stayed high and inflation stayed low (measured by the core Consumer Price Index).
Addison Wiggin noted in his November 4 Five Minute Forecast that this essentially meant the Fed planned to monetize the whole deficit for the next eight months. He quoted Agora Financial’s Bill Bonner:
If this were Greece or Ireland, the government would be forced to cut back. With quantitative easing ready, there is no need to face the music.
That was meant as a criticism, but you could also see it as a very good deal. Why pay interest to foreign central banks when you can get the money nearly interest-free from your own central bank? In eight months, the Fed will own more Treasuries than China and Japan combined, making it the largest holder of government securities outside the government itself.
The Overrated Hazard of Inflation
The objection of the deficit hawks, of course, is that this will be massively inflationary, diluting the value of the dollar; but a close look at the data indicates that these fears are unfounded.
Adding money to the money supply is obviously not hazardous when the money supply is shrinking, and it is shrinking now. Financial commentator Charles Hugh Smith estimates that the economy faces $15 trillion in writedowns in collateral and credit, based on projections from the latest Fed Flow of Funds. The Fed's $2 trillion in new credit/liquidity is therefore insufficient to trigger either inflation or another speculative bubble.
In any case, Chairman Bernanke maintains that QE involves no printing of new money. It is just an asset swap on the balance sheets of the bondholders. The bondholders are no richer than before and have no more money to spend than before.
Professor Warren Mosler explains that the bondholders hold the bonds in accounts at the Fed. He says, “U.S. Treasury securities are accounted much like savings accounts at a normal commercial bank.” They pay interest and are considered part of the federal debt. When the debt is “paid” by repurchasing the bonds, all that happens is that the sums are moved from the bondholder’s savings account into its checking account at the Fed, where the entries are no longer considered part of the national debt. The chief difference is that one account bears interest and the other doesn’t.
What About the Inflation in Commodities?
Despite surging commodity prices, the overall inflation rate remains very low, because housing has to be factored in. The housing market is recovering in some areas, but housing prices overall have dropped 28% from their peak. Main Street hasn’t been flooded with money; the money has just shifted around. Businesses are still having trouble getting reasonable loans, and so are prospective homeowners.
As for the obvious price inflation in commodities -- notably gold, silver, oil and food -- what is driving these prices up cannot be an inflated U.S. money supply, since the money supply is actually shrinking. Rather, it is a combination of factors including (a) heavy competition for these scarce goods from developing countries, whose economies are growing much faster than ours; (b) the flight of “hot money” from the real estate market, which has nowhere else to go; (c) in the case of soaring food prices, disastrous weather patterns; and (d) speculation, which is fanning the flames.
Feeding it all are the extremely low interest rates maintained by the Fed, allowing banks and their investor clients to borrow very cheaply and invest where they can get a much better return than on risky domestic loans. This carry trade will continue until something is done about the interest tab on the federal debt.
The ideal alternative would be for a transparent and accountable government to issue the money it needs outright, a function the Constitution reserves to Congress; but an interest-free loan from the Federal Reserve rolled over indefinitely is the next best thing.
A Bold Precedent
QE2 is not a “helicopter drop” of money on the banks or on Main Street. It is the Fed funding the government virtually interest-free, allowing the government to do what it needs to do without driving up the interest bill on the federal debt – an interest bill that need not have existed in the first place. As Thomas Edison said, “If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good, makes the bill good, also.”
The Fed failed to revive the economy with QE1, but it could redeem itself with QE2, a bold precedent that might inspire other countries to break the chains of debt peonage in the same way. QE2 is the functional equivalent of what many countries did very successfully before the 1970s, when they funded their governments with interest-free loans from their own central banks.
Countries everywhere are now suffering from debt deflation. They could all use a good dose of their own interest-free national credit, beginning with Ireland and Greece.
by: Ellen Brown November 19, 2010 Font Size: PrintEmail Recommend 4 Share this page
The deficit hawks are circling, hovering over QE2, calling it just another inflationary bank bailout. But unlike QE1, QE2 is not about saving the banks. It’s about funding the federal deficit without increasing the interest tab, something that may be necessary in this gridlocked political climate just to keep the government functioning.
On November 15, the Wall Street Journal published an open letter to Fed Chairman Ben Bernanke from 23 noted economists, professors and fund managers, urging him to abandon his new “quantitative easing” policy called QE2. The letter said:
We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. . . . The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.
The Pragmatic Capitalist (Cullen Roche) remarked:
Many of the people on this list have been warning about bond vigilantes while also comparing the USA to Greece for several years now. Of course, they’ve been terribly wrong and it is entirely due to the fact that they do not understand how the US monetary system works. . . . What’s unfortunate is that these are many of our best minds. These are the people driving the economic bus.
The deficit hawks say QE is massively inflationary; that it is responsible for soaring commodity prices here and abroad; that QE2 won’t work any better than an earlier scheme called QE1, which was less about stimulating the economy than about saving the banks; and that QE has caused the devaluation of the dollar, which is hurting foreign currencies and driving up prices abroad.
None of these contentions is true, as will be shown. They arise from a failure either to understand modern monetary mechanics (see links at The Pragmatic Capitalist and here) or to understand QE2, which is a different animal from QE1. QE2 is not about saving the banks, or devaluing the dollar, or saving the housing market. It is about saving the government from having to raise taxes or cut programs, and saving Americans from the austerity measures crippling the Irish and the Greeks; and for that, it may well be the most effective tool currently available. QE2 promotes employment by keeping the government in business. The government can then work on adding jobs.
The Looming Threat of a Crippling Debt Service
The federal debt has increased by more than 50% since 2006, due to a collapsed economy and the highly controversial decision to bail out the banks. By the end of 2009, the debt was up to $12.3 trillion; but the interest paid on it ($383 billion) was actually less than in 2006 ($406 billion), because interest rates had been pushed to extremely low levels. Interest now eats up nearly half the government’s income tax receipts, which are estimated at $899 billion for FY 2010. Of this, $414 billion will go to interest on the federal debt. If interest rates were to rise just a couple of percentage points, servicing the federal debt would consume over 100% of current income tax receipts, and taxes might have to be doubled.
As for the surging commodity and currency prices abroad, they are not the result of QE. They are largely the result of the U.S. dollar carry trade, which is the result of pressure to keep interest rates artificially low. Banks that can borrow at the very low fed funds rate (now 0.2%) can turn around and speculate abroad, reaping much higher returns.
Interest rates cannot be raised again to reasonable levels until the cost of servicing the federal debt is reduced; and today that can be done most expeditiously through QE2 -- “monetizing” the debt through the Federal Reserve, essentially interest-free. Alone among the government’s creditors, the Fed rebates the interest to the government after deducting its costs. In 2008, the Fed reported that it rebated 85% of its profits to the government. The interest rate on the 10-year government bonds the Fed is planning to buy is now 2.66%. Fifteen percent of 2.66% is the equivalent of a 0.4% interest rate, the best deal in town on long-term bonds.
A Reluctant Fed Steps Up to the Plate
The Fed was strong-armed into rebating its profits to the government in the 1960s, when Wright Patman, Chairman of the House Banking and Currency Committee, pushed to have the Fed nationalized. According to Congressman Jerry Voorhis in The Strange Case of Richard Milhous Nixon (1973):
As a direct result of logical and relentless agitation by members of Congress, led by Congressman Wright Patman as well as by other competent monetary experts, the Federal Reserve began to pay to the U.S. Treasury a considerable part of its earnings from interest on government securities. This was done without public notice and few people, even today, know that it is being done. It was done, quite obviously, as acknowledgment that the Federal Reserve Banks were acting on the one hand as a national bank of issue, creating the nation’s money, but on the other hand charging the nation interest on its own credit – which no true national bank of issue could conceivably, or with any show of justice, dare to do.
Voorhis went on, “But this is only part of the story. And the less discouraging part, at that. For where the commercial banks are concerned, there is no such repayment of the people’s money.” Commercial banks do not rebate the interest, said Voorhis, although they also “‘buy’ the bonds with newly created demand deposit entries on their books – nothing more.”
After the 1960s, the policy was to fund government bonds through commercial banks (which could collect interest) rather than through the central bank (which could not). This was true not just in the U.S. but in other countries, after a quadrupling of oil prices combined with abandonment of the gold standard produced “stagflation” that was erroneously blamed on governments “printing money.”
Consistent with that longstanding policy, Chairman Bernanke initially resisted funding the federal deficit. In January 2010, he admonished Congress:
We're not going to monetize the debt. It is very, very important for Congress and administration to come to some kind of program, some kind of plan that will credibly show how the United States government is going to bring itself back to a sustainable position.
His concern, according to The Washington Times, was that “the impasse in Congress over tough spending cuts and tax increases needed to bring down deficits will eventually force the Fed to accommodate deficits by printing money and buying Treasury bonds.”
That impasse crystallized on November 3, 2010, when Republicans swept the House. There would be no raising of taxes on the rich, and the gridlock in Congress meant there would be no budget cuts either. Compounding the problem was that over the last six months, China has stopped buying U.S. debt, reducing inflows by about $50 billion per month.
QE2 Is Not QE1
In QE1, the Fed bought $1.2 trillion in toxic mortgage-backed securities off the books of the banks. QE1 mirrored TARP, the government’s Troubled Asset Relief Program, except that TARP was funded by the government with $700 billion in taxpayer money. QE1 was funded by the Federal Reserve with computer keystrokes, simply by crediting the banks’ reserve accounts at the Fed.
Pundits were predicting that QE2 would be more of the same, but it turned out to be something quite different. Immediately after the election, Bernanke announced that the Fed would be using its power to purchase assets to buy federal securities on the secondary market -- from banks, bond investors and hedge funds. (In the EU, the European Central Bank began a similar policy when it bought Greek bonds on the secondary market.) The bond dealers would then be likely to use the money to buy more Treasuries, increasing overall Treasury sales.
The bankers who applauded QE1 were generally critical of QE2, probably because they would get nothing out of it. They would have to give up their interest-bearing bonds for additional cash reserves, something they already have more of than they can use. Unlike QE1, QE2 was designed, not to help the banks, but to relieve the pressure on the federal budget.
Bernanke said the Fed would buy $600 billion in long-term government bonds at the rate of $75 billion per month, filling the hole left by China. An estimated $275 billion would also be rolled over into Treasuries from the mortgage-backed securities the Fed bought during QE1, which are now reaching maturity. More QE was possible, he said, if unemployment stayed high and inflation stayed low (measured by the core Consumer Price Index).
Addison Wiggin noted in his November 4 Five Minute Forecast that this essentially meant the Fed planned to monetize the whole deficit for the next eight months. He quoted Agora Financial’s Bill Bonner:
If this were Greece or Ireland, the government would be forced to cut back. With quantitative easing ready, there is no need to face the music.
That was meant as a criticism, but you could also see it as a very good deal. Why pay interest to foreign central banks when you can get the money nearly interest-free from your own central bank? In eight months, the Fed will own more Treasuries than China and Japan combined, making it the largest holder of government securities outside the government itself.
The Overrated Hazard of Inflation
The objection of the deficit hawks, of course, is that this will be massively inflationary, diluting the value of the dollar; but a close look at the data indicates that these fears are unfounded.
Adding money to the money supply is obviously not hazardous when the money supply is shrinking, and it is shrinking now. Financial commentator Charles Hugh Smith estimates that the economy faces $15 trillion in writedowns in collateral and credit, based on projections from the latest Fed Flow of Funds. The Fed's $2 trillion in new credit/liquidity is therefore insufficient to trigger either inflation or another speculative bubble.
In any case, Chairman Bernanke maintains that QE involves no printing of new money. It is just an asset swap on the balance sheets of the bondholders. The bondholders are no richer than before and have no more money to spend than before.
Professor Warren Mosler explains that the bondholders hold the bonds in accounts at the Fed. He says, “U.S. Treasury securities are accounted much like savings accounts at a normal commercial bank.” They pay interest and are considered part of the federal debt. When the debt is “paid” by repurchasing the bonds, all that happens is that the sums are moved from the bondholder’s savings account into its checking account at the Fed, where the entries are no longer considered part of the national debt. The chief difference is that one account bears interest and the other doesn’t.
What About the Inflation in Commodities?
Despite surging commodity prices, the overall inflation rate remains very low, because housing has to be factored in. The housing market is recovering in some areas, but housing prices overall have dropped 28% from their peak. Main Street hasn’t been flooded with money; the money has just shifted around. Businesses are still having trouble getting reasonable loans, and so are prospective homeowners.
As for the obvious price inflation in commodities -- notably gold, silver, oil and food -- what is driving these prices up cannot be an inflated U.S. money supply, since the money supply is actually shrinking. Rather, it is a combination of factors including (a) heavy competition for these scarce goods from developing countries, whose economies are growing much faster than ours; (b) the flight of “hot money” from the real estate market, which has nowhere else to go; (c) in the case of soaring food prices, disastrous weather patterns; and (d) speculation, which is fanning the flames.
Feeding it all are the extremely low interest rates maintained by the Fed, allowing banks and their investor clients to borrow very cheaply and invest where they can get a much better return than on risky domestic loans. This carry trade will continue until something is done about the interest tab on the federal debt.
The ideal alternative would be for a transparent and accountable government to issue the money it needs outright, a function the Constitution reserves to Congress; but an interest-free loan from the Federal Reserve rolled over indefinitely is the next best thing.
A Bold Precedent
QE2 is not a “helicopter drop” of money on the banks or on Main Street. It is the Fed funding the government virtually interest-free, allowing the government to do what it needs to do without driving up the interest bill on the federal debt – an interest bill that need not have existed in the first place. As Thomas Edison said, “If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good, makes the bill good, also.”
The Fed failed to revive the economy with QE1, but it could redeem itself with QE2, a bold precedent that might inspire other countries to break the chains of debt peonage in the same way. QE2 is the functional equivalent of what many countries did very successfully before the 1970s, when they funded their governments with interest-free loans from their own central banks.
Countries everywhere are now suffering from debt deflation. They could all use a good dose of their own interest-free national credit, beginning with Ireland and Greece.
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