Why China's Heading for a Hard Landing: Gary Shilling

Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling

Illustration by Jonathan Zawada

By A. Gary Shilling Jun 27, 2011 12:01 PM GMT+0800 66 Comments

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June 28 (Bloomberg) -- Lorraine Tan, director of equity research for Asia at Standard & Poor's in Singapore, talks about China's economy and the country's stock market. Tan also discusses Europe's sovereign debt crisis, Asia's banking industry, and Federal Reserve monetary policy. She speaks with Rishaad Salamat on Bloomberg Television's "On the Move Asia." (Source: Bloomberg)

Few countries are more important to the global economy than China. But its reputation as an unstoppable giant -- as a country with an unending supply of cheap labor and limitless capacity for growth -- masks some serious and worsening economic problems.

China’s labor force is aging. Its consumers save too much and spend too little. Its political and economic policy tools remain crude. Its state bureaucracy seems likely to curb spending just as exports weaken, and thus risks deflation. As U.S. consumers retrench, and as the global commodity bubble begins to dissipate, these fundamental weaknesses will combine in a way that’s unlikely to end well for China -- or for the rest of the world.
To start, China is much more vulnerable to an international slowdown than is generally understood. In late 2007, my firm’s research found that too few people in China had the discretionary spending capability to support its economy domestically. Our analysis showed that it took a per-capita gross domestic product of about $5,000 to have meaningful discretionary spending power in China.
About 110 million Chinese had that much or more, but they constituted only 8 percent of the population and accounted for just 35 percent of GDP in 2009, while exports accounted for 27 percent. Even China’s middle and upper classes had only 6 percent of Americans’ purchasing power.

Why Overconfidence Abounds

With such limited domestic spending, why do so many analysts predict that China can continue its robust growth?

In part because they believe in the misguided concept of global decoupling -- the idea that even if the U.S. economy suffers a setback, the rest of the world, especially developing countries such as China and India, will continue to flourish. Recently -- after China’s huge $586 billion stimulus program in 2009; massive imports of industrial materials such as iron ore and copper; booms in construction of cement, steel and power plants, and other industrial capacity; and a pickup in economic growth -- the decoupling argument has been back in vogue.

This concept is flawed for a simple reason: Almost all developing countries depend on exports for growth, a point underscored by their persistent trade surpluses and the huge size of Asian exports relative to GDP. Further, the majority of exports by Asian countries go directly or indirectly to the U.S. We saw the effects of this starting in 2008: As U.S. consumers retrenched and global recession reigned, China and most other developing Asian countries suffered keenly.

Overconfidence in China’s ability to keep its economy booming is also partly psychological. It reminds me of the admiration and envy (even fear) that many felt toward Japan during its bubble days in the 1980s. As Japanese companies bought California’s Pebble Beach, Iowa farmland and Rockefeller Center in New York, what was safe from their zillions? Then the Japanese stock and real-estate bubbles collapsed, and Japan entered the deflationary depression in which it’s still mired.

Success and Complacency

What’s more, China’s recent successes have been so pronounced that they’ve led many to conclude that its economy is a juggernaut. And, indeed, the Chinese have much to be proud of: Last year, China passed Japan to become the world’s second largest economy, a huge achievement considering China started in the late 1970s with a tiny pre-industrialized economy.

But this success may have led to complacency. I suspect that the 2007-2009 global recession, and the dramatic transformation by U.S. consumers from gay-abandon borrowers-and- spenders to Scrooge-like savers, caught Chinese leaders flat- footed. They probably planned to encourage consumer spending and domestic-led growth, but later -- much later.

Growth Machine

They were enjoying a well-oiled growth machine. Growing exports, especially to American consumers, stimulated the capital spending needed to produce yet more exports and jobs for the millions of Chinese streaming from farms to cities. Wages remained low, due to ample labor supplies, and held down consumer spending. So did the high Chinese consumer saving rate. Because Chinese could not invest offshore, much of that saving went into state banks at low interest rates. The money was then lent to the many inefficient government-owned enterprises at subsidized rates.

In a country where stability is almost worshipped, why would any leader want to disrupt such a smoothly running economy?

But before you worry about China’s becoming No. 1 any time soon, consider the remaining gap between its economy and the U.S. economy. In 2009, China’s GDP was $4.9 trillion, only 34 percent of the U.S.’s $14.3 trillion. Because China has 1.32 billion people, or 4.3 times as many as the U.S. has, the gap in per-capita GDP was even bigger: China’s $3,709 was only 8 percent of the U.S.’s $46,405.

A Wide Gap

Just to maintain this gap at current levels, Chinese GDP will need to grow at double-digit rates for four years before tapering off, or rise sixfold in three decades (assuming that U.S. real GDP increases 2 percent per year on average for the next 30 years, and using government population projections). To close the per-capita GDP gap in 30 years, Chinese GDP would need to grow about 10 percent per year for three decades, or expand to 17.8 times its current size in that period.
Such rates of growth seem close to impossible if the global economy slows.

As the announcer for the Cleveland Indians used to say when the Tribe was hopelessly behind, “They have their work cut out for them!”

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the first in a five-part series.)

Shilling: China Heading for a Hard Landing, Pt. 2

Illustration by Jonathan Zawada

By A. Gary Shilling Jun 28, 2011 11:01 AM GMT+0800 13 Comments

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June 28 (Bloomberg) -- Kristine Li, Singapore-based chief financial credit strategist for Asia ex-Australia at Royal Bank of Scotland Plc., talks about the health of China's banks. Li speaks with Rishaad Salamat on Bloomberg Television's "On the Move Asia." (Source: Bloomberg)

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June 28 (Bloomberg) -- Lorraine Tan, director of equity research for Asia at Standard & Poor's in Singapore, talks about China's economy and the country's stock market. Tan also discusses Europe's sovereign debt crisis, Asia's banking industry, and Federal Reserve monetary policy. She speaks with Rishaad Salamat on Bloomberg Television's "On the Move Asia." (Source: Bloomberg)

China has become an economic giant because it has so many people who are producing moderate amounts. In most ways, however, China remains an underdeveloped country with political and economic policy tools that are crude by Western standards. Those tools can spur impressive growth --but they also mask some deep structural weaknesses in China’s economy.

It’s relatively easy for developing countries to grow by emulating the technology of advanced nations or, in China’s case, by forcing them to share it as the price of doing business or by simply stealing it.

And a tightly controlled economy can get results quickly. That’s what happened with China’s $586 billion stimulus program introduced in 2009. Growth in gross domestic product leaped from a 6 percent rate in early 2009 back to double digits. Most of the money was channeled through government-controlled banks, whose lending increased by $1.4 trillion, or 32 percent, over the course of 2009 after being flat since early 2006. The money supply increased by 29 percent.

Those loans financed public and industrial infrastructure and real estate. Property prices in January 2010 were up 9.5 percent from a year earlier, according to government numbers, and much more by private realistic estimates. Employment gained along with economic activity, and in the third quarter of 2009, there were 94 job openings for every 100 applicants, up from 85 in depressed 2008, and close to the pre-crisis average of 97.

Unsustainable Growth

Here’s what we should remember: This kind of growth is unsustainable, and it won’t be able to cover up China’s underlying vulnerabilities forever.
China’s reliance on exports and a controlled currency for growth, for instance, will no longer work if U.S. consumers are engaged in a chronic saving spree, as I believe they will be. Chinese export growth, which averaged 21 percent per year in the last decade, is bound to suffer.
The country’s seemingly inexhaustible pool of cheap labor is expected to peak in 2014, in part due to its rigid one-child policy. By some estimates, ample labor has boosted GDP growth by 1.8 percentage points annually since the late 1970s, but the contraction of the working-age population will reduce growth by 0.7 percentage points by 2030.

Wages and Ages

Wages are already rising, and even Chinese manufacturers are moving production to Vietnam and Pakistan, where pay levels are a third of China’s. Some factory workers have seen wage increases of 20 percent to 30 percent in the last year or so, with those producing goods for foreign companies seeing especially large boosts. At the same time, better conditions in rural areas have reduced the flow of cheap labor into coastal cities.

As the Chinese population ages, the ratio of retirees to working-age people is forecast to rise from 39 percent last year to 46 percent in 2025.

This does not bode well for China’s future growth. When Communist Party leaders transitioned China’s economy from a cradle-to-grave nanny state to a progressively free-market one starting in 1978, no meaningful unemployment, retirement or state health systems were instituted. (Although President Hu Jintao said in October that China will “institute a social safety net that covers all,” and the government has set a goal of providing basic medical care for all Chinese by 2020.)

Prodigious Saving

So the Chinese must save prodigiously to provide for their welfare and retirement. This has contributed mightily to China’s high rate of saving and low rate of spending, and its consequent reliance on exports. Chinese households save close to 30 percent of income on average, in large part to cover old age and medical costs.

Yes, the Chinese saving rate will be pushed down in time by aging Chinese who still consume but no longer work, much as it has in Japan. Nevertheless, less saving and more Chinese consumption won’t substitute for weakening exports any time soon. Chinese consumers buy only about one-tenth of those in Europe and the U.S. combined. As the euro zone remains troubled, and the U.K. slashes government stimulus and U.S. consumers continue to retrench, it’s unlikely that a drop in Chinese saving could offset the negative effects of reduced exports.

Inflation Looming

Finally, China’s state-controlled economic boom may soon lead to crippling inflation. In February 2010, the director of the National Bureau of Statistics said that “asset-price increases pose a challenge for macroeconomic policy.”

The housing boom has pushed up prices to the point that apartments in Beijing are affordable to only the top 20 percent of earners -- they’re selling at about 22 times average income (average U.S. house prices peaked at six times average income). A square meter of property in China costs an estimated 164 times per-capita income, compared with 33 times in high-priced Japan.

The 2009 stimulus package also spurred consumer price inflation to a year-over-year acceleration of 5.5 percent in May. Food prices are very sensitive politically because so many Chinese are at subsistence incomes, and they rose 11.7 percent in May from a year earlier.
Chinese leaders are not amused, and are taking stringent restraining actions. But with only blunt-force economic tools available, it’s not clear that they’ll be capable of managing a controlled slowdown without significant pain.
(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the second in a five-part series.)

So Greece will avert a default once more, with its well-meaning neighbours pumping morphine into a terminally ill patient. Ultimately, it may be cheaper for Greece to default. The EUR is too expensive for Greece, making it uncompetitive. By defaulting, the Greeks can revert to Drachmas which will further devalue. It will cause turmoil for the financial markets but if they bail out their domestic banks things should be under control. True, if Greece defaults they won't be able to borrow. But if we follow the Russian example, they moved quickly back into the black within a year of their default. Their currency devalued so much that they started to achieve a trade surplus.

The problem with the current bailout is that it doesn't stimulate Greece's growth. They should restructure their economy to make it more competitive. Labour markets should be more free.

The US debt ceiling should be raised without problems in Aug 2011. The end of QE2 should be factored mostly by the market. So why is the credit spread still rising? why did it rise to 348 bps today? Is there something lurking in the corner?

I am still very cautious. Will a reversal in the short term looks possible now, no rebound is sustainable if the credit markets don't tighten. Stay tuned. I'll start buying in July. We'll see.

European Banks Near 70% Greek Rollover Deal

By Aaron Kirchfeld and Helene Fouquet - Jun 27, 2011 8:21 PM GMT+0800

France's President Nicolas Sarkozy. Photographer: Jock Fistick/Bloomberg

Greek creditors may be headed toward an agreement to roll over 70 percent of their bonds into longer maturity debt to prevent a default and meet politicians’ calls that they contribute to Greece’s second rescue in as many years.
“We’ve been working on this,” and hope other countries will join the proposal, French President Nicolas Sarkozy said today at a press conference in Paris. Germany’s biggest banks and insurers are weighing the French proposal, a person familiar with the matter said today.
German and French lenders are the biggest European holders of Greek debt and their participation in the plan is key to achieving a European Union goal to get banks to roll over at least 30 billion euros ($43 billion) of bonds. The rollover is part of a broader aid package that EU leaders have pledged to pass next month to prevent the euro-region’s first default a year after the 110 billion-euro Greek bailout that failed to stop the debt crisis.
The Markit iTraxx SovX WE gauge of default swaps on 15 governments rose 5.5 basis points to 247.5, after earlier reaching a record, and contracts tied to Greece climbed 23 basis points to 2,138, signaling an 84 percent probability of default within five years, according to CMA. Swaps insuring Irish bonds added 27 basis points to an all-time high 832 and Portugal increased 21 to a record 859.

Eligible Bonds

European banks hold 17.2 billion euros of Greek bonds maturing by the end of 2013, Citigroup Inc. (C) estimated in a June 23 report. Greek banks, which will join a rollover, hold almost 22 billion euros of bonds maturing in that period and the country’s central bank owned 5.1 billion euros of the debt likely eligible for the rollover, Citigroup estimated.
France’s proposal for a 70 percent participation target came after separate talks last week with German, Dutch, Belgian and French banks on the rollover. “The German government welcomes it when proposals come from the private sector, including those on private-creditor participation that are now coming out of France,” German Finance Ministry spokesman Martin Kreienbaum told reporters in Berlin today. Talks with German financial institutions are ongoing, he said.
“If the private sector is voluntarily getting involved then that would be seen as positive because it would help avert a Greek default,” said Orlando Green, a fixed-income strategist at Credit Agricole SA (ACA) in London.

Special Fund

Under the French plan, 50 percent of the Greek debt held would be rolled over into 30-year bonds. The remaining 20 percent would go into a special purpose vehicle used to guarantee the 30-year debt, a person familiar with the plan said yesterday.
Negotiations shifted to Rome today where Director General of the Treasury Vittorio Grilli hosted representatives of some of the world’s biggest banks. Grilli is chairing the meeting in his capacity as the head of the European Union’s Economic and Finance Committee, which helps prepare policy for European finance ministers. He is in discussion with a group of bank executives and Charles Dallara, managing director of the Institute of International Finance, which represents more than 400 of the worlds’ biggest financial services companies.

EU, ECB

The European Commission and the euro zone were represented at a technical level at the Rome meeting, commission spokesman Amadeu Altafaj said today in Brussels. The European Central Bank, the biggest holder of Greek debt, was also taking part in the Rome talks, according to a person familiar with the negotiations.
Sarkozy insisted that any participation by banks had to be voluntary. Credit rating companies have threatened to rule Greece in default if banks are coerced into rolling over debt, a move that would devastate the country’s banking system and possibly drag down other high-debt nations such as Portugal, Ireland and Spain.
“If it wasn’t voluntary, it would be viewed as a default, with huge risks of catastrophic results,” Sarkozy said.
The European Commission also insisted that “there is no coercive element envisioned,” Altafaj said. “We don’t want under any circumstances there to be any kind of selective default.”
To contact the reporter on this story: Aaron Kirchfeld in Frankfurt at Helene Fouquet in Paris at hfouquet1@bloomberg.net
To contact the editor responsible for this story: Frank Connelly at fconnelly@bloomberg.net

2011 Market Mirroring 2010: Expect Further Drop When QE2 Ends

 by: One Eyed Guide June 21, 2011 |

 

As of Friday, June 17, 2011, the S&P 500 was exactly flat for the year while it was down 1.5% on the same date in 2010. Looking at performance for the year in the chart below, the overall movement in the last few months is scarily similar (click to enlarge image):

Weighting down the market is the fact that earnings are flattening out today - while they were growing strongly in 2010 - and that QE2 is ending on June 30. Plus the Greek default crisis plus a slowing economy plus ... I'm sure you can add something.
With nothing positive on the horizon, a further decline of at least 10 % to around 1100 appears possible between July and September. QE3 will probably be announced (or hinted at as it was in 2010) as the market approaches a 20% "bear market" decline.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours.

Stocks Cheapest in 26 Years as Profits Rise

This is why I don't think the peak of stocks / commodities has been reached.

 

Stocks Cheapest in 26 Years as Profits Rise

By Alexis Xydias - Jun 20, 2011 10:21 PM GMT+0800

Traders work on the floor of the New York Stock Exchange in New York. The combination of China raising interest rates, concerns about a Greek default and the end of the Federal Reserve’s $600 billion stimulus program have almost wiped out this year’s gains. Photographer: Jin Lee/Bloomberg

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June 13 (Bloomberg) -- Doug Cliggott, U.S. equity strategist at Credit Suisse, talks about the outlook for the U.S. stock market and investor sentiment. Cliggott speaks with Deirdre Bolton on Bloomberg Television's "InsideTrack." (Source: Bloomberg)(Source: Bloomberg)

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June 17 (Bloomberg) -- Bloomberg's Deborah Kostroun reports on the performance of the U.S. equity market today. U.S. stocks snapped a six-week decline as European leaders moved closer to a compromise on a financial rescue for Greece and an index of leading American economic indicators advanced more than forecast. Bloomberg's Pimm Fox also reports. (Source: Bloomberg)

For the second time since the bull market began, profits are surging and stocks are falling.
Standard & Poor’s 500 Index companies will earn 18 percent more this year than in 2010, according to the average estimate of more than 9,000 analysts compiled by Bloomberg. Higher profits haven’t stopped the gauge from falling 6.8 percent since April 29, pushing valuations to the cheapest levels in 26 years. Even if companies posted no growth, price-earnings ratios would be lower than on 96 percent of days in the past two decades.
The combination of China raising interest rates, concerns about a Greek default and the end of the Federal Reserve’s $600 billion stimulus program have almost wiped out this year’s gains. The divergence between profit forecasts and economic indicators shows the challenge to investors after the S&P 500 gained 88 percent from a 12-year low in March 2009.
“The market is not willing to pay for future growth,” said Nigel Holland, who helps oversee $516 billion at Legal & General Group Plc in London. “Provided there is better data, it will stabilize,” he said. “The market probably has room to rise 10 percent by year-end.”
The S&P 500 climbed less than 0.1 percent to 1,271.50 last week, snapping its longest retreat since 2008, after reports on jobless claims, retail sales and Chinese industrial production exceeded economists’ forecasts and German Chancellor Angela Merkel retreated from demands that bondholders be forced to swallow losses in a Greek rescue.
The S&P 500 fell 0.1 percent to 1,270.31 at 10:18 a.m. in New York today.

Longest Streaks

Equities also got a boost as retailers Best Buy Co. and Kroger Co. (KR) said they would match or exceed predictions for 2011 income. The advance pared the S&P 500’s loss from its 2011 peak of 1,363.61 on April 29 to 92.11 points.
At 34 days, the decrease is the second longest since the bull market began. The 16 percent tumble from April to July 2010 lasted 49 days, Bloomberg data show. This year’s retreat has coincided with a decline in predictions for 2011 gross domestic product growth to 2.6 percent from 3.2 percent, according to the median estimate of 83 economists surveyed by Bloomberg.
Losses since April have pushed the price of the S&P 500 to 14.5 times the past year’s earnings, compared with the average of 20.5 since June 1991, according to Bloomberg data. The gauge is valued at 8.7 times cash flow, cheaper than in 81 percent of occasions since 1998. The gauge is priced at 2.1 times book value, or assets minus liabilities, lower than it has traded 90 percent of the time since 1995.

Not Excessive

“Even in the assumption that earnings growth is zero, valuations would not be excessively high,” said Patrick Moonen, who helps manage $537 billion at ING Investment Management in The Hague, Netherlands. “We are below consensus in the estimated earnings growth, and still think the corporate momentum is very strong.”
Disappointing reports since May on housing, employment and manufacturing have heightened concerns that $600 billion in Treasury purchases by the Fed have failed to bolster growth. The S&P 500 posted its biggest weekly decline since August in the period that ended June 3 after the U.S. jobless rate unexpectedly climbed to 9.1 percent and payrolls expanded at the slowest pace in eight months. A report from the Institute for Supply Management on June 1 showed that manufacturing expanded at the lowest rate in more than a year.

Greek Swaps Soar

The cost of insuring against defaults on Greek, Irish and Portuguese government debt surged to records last week on concern governments will fail to impose spending cuts needed for a European Union debt restructuring.
Credit-default swaps on Greece soared as much as 459 basis points to 2,237 on June 16, according to CMA prices, meaning it cost more than 2 million euros ($2.9 million) a year to insure 10 million euros worth of the nation’s debt.
They traded at 1,932.75 basis points as of 4:30 p.m. in London on June 17 as Merkel backed down from her demands and said she’d work with the European Central Bank to avoid market disruptions.
Investors are concerned about slowing growth in the U.S. and Europe’s sovereign debt crisis at the same time policy makers in China, the world’s second-largest economy, are trying to cool expansion. The country’s central bank has raised the reserve-requirement ratio for lenders 11 times and boosted interest rates four times since the start of 2010 to keep inflation in check.

Lehman, 1980s

Analysts are boosting profit forecasts even with the global economy showing signs of weakness. S&P 500 earnings may rise to $99.61 a share in 2011 from $84.58 last year and $61.52 in 2009, according to data compiled by Bloomberg. That’s an increase from the forecast of $95.37 on Jan. 3 and $98.70 on April 29, the data show.
Should stocks stay at current prices and the analyst prediction come true, the S&P 500 would trade at 12.8 times income on Dec. 31, the lowest level since 1985 except for the six months after Lehman Brothers Holdings Inc.’s bankruptcy in September 2008 and nine months in the late 1980s, according to Bloomberg data. Companies in the S&P 500 are forecast to earn $24.31 this quarter, up from $24.16 at the start of April.
Concern the slowdown will lead to another recession will weigh on stocks even as companies report higher income, said Doug Cliggott, Boston-based equity strategist at Credit Suisse Group AG. He said the S&P 500 will be little changed through year-end.

Not Extreme

“We wouldn’t put the market now as extremely rich or in a sense extremely attractively valued,” Cliggott said in an interview on Bloomberg Television’s “InsideTrack” with Deirdre Bolton on June 13. “Price-earnings multiples will be at or below their historical averages because of all the uncertainties on future growth.”
Stocks may also have to do without more stimulus from the Fed, which will complete its second round of Treasury purchases this month. While Fed Chairman Ben S. Bernanke said during a June 7 speech in Atlanta that record monetary stimulus is still needed to boost the “frustratingly slow” U.S. economic recovery, he gave no indication that the central bank will start a third round of so-called quantitative easing.
Retreats in the S&P 500 that exceed 5 percent are common during bull markets, according to data from Birinyi Associates Inc., the Westport, Connecticut-based money manager and research firm. During the nine rallies between 1962 and 2007, the S&P 500 fell that much an average of seven times, the data show. The index has posted nine such retreats during the current advance.

‘Strong Backbone’

Global investors increased their cash holdings to the highest level in a year this month as hedge funds slashed the amount of borrowed money invested in stocks, a survey from Bank of America Corp. (BAC)’s Merrill Lynch unit showed on June 14.
“Valuation is a strong backbone,” ABN Amro Private Banking Chief Investment Officer Didier Duret, who manages about $200 billion in Geneva, said in a telephone interview. “It’s more or less a reflection of how reluctant investors have been to get back into the equity market.”
Kroger in Cincinnati rose 4.5 percent, the most since October 2009, to $23.99 on June 16. The largest U.S. grocery chain increased its fiscal 2012 earnings forecast to as much as $1.95 a share from $1.92. Analysts, on average, estimated $1.90.
Best Buy, the world’s biggest consumer-electronics retailer, rallied 4.6 percent two days earlier after reporting profit that exceeded analysts’ forecasts, helped by rising demand for smartphones. The Richfield, Minnesota-based company reiterated its full-year projection for earnings per share of $3.30 to $3.55, excluding restructuring costs. Analysts predicted $3.47.
To Alison Porter at Ignis Asset Management, stocks have priced in prospects for a Greek default and the end of the Fed’s bond-buying program.
“We are seeing stable growth, but it is not a strong cyclical recovery,” said Porter, who as U.S. equities fund manager in Glasgow helps oversee $123 billion. Still, “valuations in the market should provide some support,” she said. “Equities are reasonably well positioned from here.”
To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net
To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net

Jamie Olliver's Food Revolution Episode 1

http://www.youtube.com/watch?v=vXaeKL87CcY

Folks, watch this. This is exactly how I feel. I tried so hard to make things right, to protect the folks. But they cannot understand certain issues.

Very Disappointing Fear Indicator

I was hoping for this fear indicator to come down. But I was wrong. It rose to the highest level since Aug 2010. So far, stock markets haven't fallen by 20 - 25% like it did in May 2010 so I'm expecting another sell down after this week of rebound.

I was hoping that a rebound would come after 6 consecutive weeks of sell down. After all, the Greek situation is almost going to be resolved via a bailout. Lehman's meltdown is still fresh on the minds of regulators. It's either a rollover of the same debt to prevent banks from being hit in their capital, or a wholesale bailout by ECB. ECB has to accept Greek debt as collaterals even if the debts are rolled over otherwise the country will grind to a standstill. Anything less than that will result in French and German banks taking a hit in their capital and becoming insolvent. In the end, ECB will have to bail out the German and French banks otherwise it will be a systemic failure of the banking system again, only this time it is of a much larger magnitude.

For the Greek government, agreeing to a harsh austerity plan will mean more riots on the streets and a deeper recession. There seem to be no light at the end of the tunnel. A bailout will mean kicking the can further down the road. If they decide to default, it will mean no more borrowing from the bond markets. It will mean bankruptcy like Russia in 1998 and Argentina in 2002. They won't be able to borrow again until all debts are settled, or IMF - ECB agree to forgiveness. But forgiveness doesn't come cheap. Greece will have to privatise a lot of national assets to become foreign owned. So remaining in the EU and defaulting on their debt is not palatable either. Damn if they accept the austerity measure, damn if they choose bankruptcy.

Let's explore Greece breaking away from the EU. It will almost certainly mean the meltdown of French - German banks. It will start a contagion that will affect American, Swiss and British banks too. It will be Lehman crisis all over again. It means the Greeks will have to turn back to Drachmas, which will almost certainly crash after reversion. It will mean a default of their current bonds. Nobody will buy Greek bonds in Drachmas. It will mean hyper-inflation and perhaps a Zimbabwe-like hyper-inflation. ECB will count the massive costs because Euro confidence will be hit. Euro will crash.

So the third option will not only kill Greece, but the EU too. It is unpalatable to both.

The best option is to accept a watered-down austerity measure and allow for voluntary roll-over of the same debt. Greece can take a longer time to balance its fiscal books. The world will calm down again. It will happen because collateral damage is far too big to stomach.

But what's causing the fear indicator to rise? I am worried that there are unknown factors. Perhaps the debt ceiling in the US will not be raised, although I am quite sure this won't happen. Perhaps QE2's end will push the US economy over a cliff. This is possible although I find it strange that QE should be such an issue when it didn't even flow into the money supply of the US in the first place. With the end of QE2, interest rates could rise and UST plummets. Unless the bears think a recession will occur and buy up those USTs. Investors should be putting money in equities and commodities because no other sector, not in the least cash will give them higher than inflation returns. The earnings yield gap is still super wide, with PE at 12x, or 8% yield, and 5y UST at around 2.5%, the gap is around 5.5%. It makes far more sense to invest in equities than Treasuries or USTs.

Another possibility is China's bubble has burst and the news hasn't reached us yet. The property bubble could be far worse than expected. I am staying clear for now. This rebound doesn't look sustainable.

I think we could see a sell down soon before we see a strong rebound. I don't think this is the peak but next year could be it.

2.536%

VALUE: 283.000 USD

JACI composite Blended Spread (JACICOBS:IND)

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Summary			One-Year Chart INTERACTIVE CHART
Value	283.00
Change	7.000 (2.536%)
Open	283.00
High	283.00
Low	283.00

Greek Default May Be Inevitable

It seems inevitable that Greece will encounter some form of soft restructuring. I have highlighted some important issues to take note. Frankly, I think the debt issues will be contained and the correction of stocks is overdone. But I'm waiting for that one indicator to normalise before I pile on my investments into risky assets.   Published June 17, 2011

Greek default may be inevitable A default verdict from rating agencies looks likely, but this may be temporary and not too damaging By NEIL UNMACK AND GEORGE HAY WHEN is a country in default? In Greece's case, the answer depends on who you ask. Eurozone politicians want holders of the country's bonds to help contribute to another bailout. However, they also want to avoid the wider market fallout that a default would bring. Getting accountants, rating agencies, derivative traders and the European Central Bank (ECB) to agree will be hard. But not all opinions have equal weight. Lenders' take: For banks, the question is whether an exchange or extension forces them to recognise a loss on their bonds. That would have severe ramifications for Greek banks and would also hurt French and German lenders A debt restructuring could take several forms. One option is to ask creditors to exchange Greek government paper into new, longer-dated bonds. The alternative is to persuade holders of maturing Greek debt to voluntarily roll over their holdings into new bonds. Different groups are likely to have differing opinions on whether this counts as a default. Banks For banks, the question is whether an exchange or extension forces lenders to recognise a loss on their bonds. That would have severe ramifications for Greek banks, which hold 48 billion euros (S$84 billion) of the country's debt, and would also hurt French and German lenders. But banks may be able to avoid taking a hit. Accounting rules are strict on obvious defaults. If the issuer of a bond cuts the coupon or refuses to pay back all of the principal amount then the bank must register a loss. But there is more leeway on milder 'reprofilings'. If the issuer keeps up interest payments, pledges to repay the principal in full, and only extends the maturity, banks do not have to class the bond as impaired. Of all the opinions, the banks and the ECB are most important. So long as a rollover or extension doesn't undermine the solvency of the banking system, and as long as the ECB continues to fund peripheral lenders, a systemic crisis should be averted. True, the market value of the bond is lower, as the repayment date has been pushed out. But this only applies to bonds that are held in banks' trading books, which are marked to market. Most banks now hold sovereign debt in their banking books, where accounting valuations rule. Exchanging existing bonds for new ones could be harder to get past the auditors, because accounting rules technically deem this to be a sale - which would crystallise losses - rather than just an extension. But there are no explicit rules on the accounting treatment of such manoeuvres. It should therefore be possible for bank chief financial officers to argue that a bond exchange and a maturity extension should have the same treatment, as long as no change has been made to the coupon or principal. ISDA Eurozone politicians also need to worry about the International Swaps and Derivatives Association, the derivatives industry body, which will decide whether or not an exchange or rollover triggers the country's credit default swaps (CDS). If it does, that would trigger losses for institutions that have sold protection against a Greece default - which have a net exposure of about US$5 billion - and a pay day for speculators. And it would be a public verdict of default. To dodge this bullet, the rollover or extension cannot be legally binding on all creditors, and will also have to avoid giving any creditors contractual seniority over other classes of debt. ECB The ECB is less worried about legal or accounting niceties. However, the central bank has so far objected to anything that changes the terms on existing bonds, because it fears this could spread panic throughout the euro zone. Politicians are understandably wary of overruling the central bank that provides the region's lenders with liquidity and protects the single currency. However, there may be some middle ground: The ECB has recently given its blessing to a voluntary rollover of Greek debt. The ECB's support is critical if Greek banks are to continue pledging government bonds as collateral with the central bank - particularly if rating agencies take a hard line. Rating agencies Even a voluntary rollover of Greek debt will be closely scrutinised by Moody's, Standard & Poor's and Fitch. Whether they classify a restructuring as a default will depend on the terms offered to investors. On paper, a voluntary exchange need not trigger a default. But any proposal that penalises investors who do not participate - for example by threatening a hard default if the offer isn't accepted, or by changing the residual bonds' tax or legal status - could prompt the ratings agencies to temporarily downgrade Greece to a selective or restricted default. Even a voluntary rollover of debt may be viewed as akin to a default. Rolling over bonds at current market rates - meaning a yield of about 15 per cent on five-year bonds - might be OK, as it would suggest that investors were entering into a commercial transaction rather than having their arms twisted. But Greece cannot afford to do that. An alternative is for Greece to sweeten the deal by offering collateral with the new bonds. But even then ratings agencies would frown on such an arrangement if they didn't believe the deal was done on commercial terms. So a default verdict from the rating agencies looks likely. But this may be temporary, and not too damaging, as investors who are forced to pay attention to ratings sold their Greek holdings when the country was downgraded to junk status. As long as the ECB is willing to keep on funding Greek banks, the fallout may be manageable. However, a Greek downgrade to default - even if temporary - could prompt downgrades of other peripheral government debt. Rating agencies might expect holders of Portuguese or Irish bonds to receive similar treatment in future. That could lead to downgrades for the eurozone periphery, and the risk of contagion. Who matters most? Of all the opinions, the banks and the ECB are most important. So long as a rollover or extension doesn't undermine the solvency of the banking system, and as long as the ECB continues to fund peripheral lenders, a systemic crisis should be averted. A rating agency default, or credit event on CDS, would have some knock-on effects, but these should be manageable. The longer-lasting impact would be the stigma that Greece was deemed to have defaulted on its debt. But that would only confirm something that most investors and analysts already believe is inevitable.

Get Ready for More Downside

Buy on dips or to cut loss? There are several issues facing stocks / commodities now. The ECB meeting on 24 June may not have an outcome. If they cannot decide on the bailout of Greece, it could be catastrophic for the world. European banks will suffer a markdown of their balance sheets. The Euro will tank. Even a delay in the decision will trigger a default that could be bigger than Lehman's bankruptcy. This is truly an event that could rock the world. Greece will not be able to borrow from debt capital markets anymore.

I suspect in the nick of time, ECB / IMF / Germany / France will decide to bail Greece out, even though the Meditteranean country cannot push through an acceptable measure.

Then there's the end of QE2 at the end of June. The Bernanke put will end. Frankly, I believe the markets have factored this in already. That's why it started to correct in May. In any case, the money from QE has not flowed into the economy as they are mostly kept with the US banks to repair their balance sheet. Some of the money did flow into the stock markets and they could be from hedge funds and fund managers who managed to dump USTs into the Fed.

The US debt ceiling of US$14 trillion will be hit in July. I believe this will be resolved between the two parties otherwise it will trigger a US default. US can't even withstand a downgrade of their credit because it will lose its status as a reserve currency and the USD will plummet. The world will look for another reserve currency and US interest rates will skyrocket, forcing the FED to come up with another QE to bail themselves out.

So what's left to spook the markets? There's plenty more. The US economic growth is weak. China's PMI is heading south and their inflation still stubbornly high.

I don't see a double dip in the US. We are in the final half of the bull rally. July may surprise everybody and the 2nd half of 2011 may be a delight.

Meanwhile, we should all survive June. We should buy Amundi Volatility World to hedge our bets. The other hedge is Schroder Gold & Precious Metals. Gold is uncorrelated to stocks. If the ECB outcome is negative, investors will flock to gold. Vix will shoot up. Templeton Global Total Return may be able to withstand this sell down.

Hang on very tight. I think 10 - 20% downside is possible.

Synthetic ETFs

Published June 10, 2011

Synthetic ETFs: knowledge is key By MICHELLE TAN POPULARISING exchange-traded funds (ETFs) seems to be one of the initiatives actively pursued by the Singapore Exchange (SGX) and global ETF sponsors as they join hands to educate the media and public on what these products have to offer. Synthetic ETFs will have its place when it comes to satisfying an investor's appetite for exposure to difficult-to-replicate physical indexes. However, like any investment, investors must do their homework. In particular, with any derivative, a little more education to the retail public would be beneficial. - Michael Chan of BNY Mellon However, the risks of ETFs are sometimes omitted at such events, making these educational efforts come across more as a sales pitch than an objective knowledge-imparting session. On the occasions when such risks were discussed, many investors still walked away as clueless as they started off due to their inability to comprehend the product and the technical lingo used. More importantly, some argue that while institutional and sophisticated investors may be equipped with the requisite knowledge and understanding of ETF methodologies to discern the benefits and downside of such products, retail investors might not possess the technical expertise to see beyond an issuer's initial marketing scheme. Furthermore, the runaway success of ETFs has led to an era of increasingly complex products using synthetic structures, placing retail investors at an even greater disadvantage in terms of comprehension. But that has not quelled the drive of ETF issuers to conjure up more synthetic products as the appeal of such ETFs far outweighs any points of apprehension, at least from their perspective. For one thing, synthetic ETF issuers are able to cut down on cost pertaining to the rebalancing of a physical portfolio and other index balances, as a synthetic ETF replicates returns via the use of derivatives, instead of a basket of physical assets. Furthermore, via the use of derivatives - such as total return swaps - synthetic-type products are able to ensure greater effectiveness in the tracking of the underlying securities, reducing overall tracking error. As such, it is no random anomaly that synthetic replication has been a key growth driver for the ETF industry over the past few years. In fact, Manooj Mistry, head of equity ETF structuring at Deutsche Bank, notes that over 50 per cent of assets under management in ETFs located in Europe are in synthetic ETFs and most new issuers are catching on fast by adopting the structure. Sceptics have, however, raised the flag as they warn against synthetic ETFs' over-reliance on derivatives in the tracking of an index objective. Notably, regulators in the US Securities and Exchange Commission (SEC) and Europe's Bank for International Settlements (BIS) have already initiated reviews in the last few months on the potential systemic risks of structured ETFs. After all, it was derivatives - in the form of credit default swaps - that crippled financial systems around the world in the fateful year of 2008, triggering one of the worst global recessions since the Great Depression of the 1930s. So it is perfectly normal - indeed, wise - for investors to practise some caution when dealing with such products. Besides, as everyone knows, there's no such thing as a free lunch in this world; good things always come at a cost. In the case of synthetic ETFs, the reduction in tracking error is exchanged for increased counterparty risk. In layman terms, counterparty risk is the probability that the total return swap provider goes bust. In the past, many would have laughed at such a thought, as counterparties were usually global investment banks that were believed to have pockets as deep as the Pacific Ocean. However, sentiment has since shifted, especially after the demise of the seemingly indestructible Lehman Brothers - which has since vanished from the face of the financial world, leaving many of its employees and investors in the lurch. In such an event, the synthetic ETF would lose its ability to generate returns, and all that investors would have to fall back upon would be collateral. But would the collateral be enough to recover all the funds an investor places in a synthetic ETF? The answer, at best, is maybe. Though in practice, excess collateral is typically used to back a synthetic ETF in times of counterparty default, there still lies the risk that the collateralised assets might not be able to be liquidated fast enough. Moreover, the longer it takes to liquidate the collateralised assets, the more likely the assets would plummet in value. In such a scenario, investors would not be able to get back the full market value of their ETF shares. So the quality of the collateral assets backing a synthetic ETF is of utmost importance, and investors should make a special effort to understand the nature of these assets before plunging into buying a synthetic ETF. Currently, a number of ETF issuers and sponsors publish their collateral policy and contents in each fund's collateral basket on the Internet for public scrutiny, although few would be able to decipher the meaning of the array of technicalities, such as product codes, so frequently used in such fact sheets. For now, there is no requirement for collateral to be held in the same securities that the ETF tracks. This suggests that a collateral basket can be filled with all kinds of controversial securities, such as junk bonds, unrated bonds and illiquid small-cap stocks - all of which would face much difficulty if there arises a need for quick liquidation. More pertinently, investors should be wary of synthetic ETFs using a funded or prepaid swap to replicate returns, as the ETF provider in such cases is not the beneficial owner of collateral assets - which implies that it can be frozen by a bankruptcy administrator in the event of a counterparty default. In such an unfortunate instance, the collateral will not be released to the ETF issuer, and some investors will inevitably be left holding the bag. All said and done, however, it's not as if synthetic ETFs should be avoided like the plague. In fact, investors who fully understand the complexities of synthetic ETFs' workings should go ahead and vest their funds in these products and capitalise on attractive features such as low management fees. On a similar note, Michael Chan from BNY Mellon reiterated: 'Synthetic ETFs will have their place when it comes to satisfying an investor's appetite for exposure to difficult-to-replicate physical indexes. However, like any investment, investors must do their homework. In particular, with any derivative, a little more education for the retail public would be beneficial.'

‘Stay out of property market for now’

By MoneyMatters.sg | Property Blog – Tue, Jun 7, 2011

Our blogger advices Singaporeans to stay out of the property market for now. (AFP file photo)

Roman Abramovich, a Russian billionaire and the 53^rd richest person according to 2011 Forbes list, said: "investors have very short memories". In today's bullish climate it is hard to imagine that just about two years ago, there were genuine fears of a global financial meltdown. These days we are no longer concerned about our assets becoming worthless; instead we are more concerned about property prices escalating beyond what we can afford.
In view of this, some people may inevitably believe that this current "bull" run will last forever and make risky investments in fear of losing out. They attempt to rationalise that it is different this time round and that the spectacular market performance is due to the emergence of Asia as a new financial powerhouse.
John Templeton, a very prominent stock investor once commented," the four most dangerous words in investing are 'This time it's different'." According to the historical URA Private Property Price Index (PPPI), we can tell that the property market is cyclical and no trend lasts forever. In a blog post I wrote in July 2009, I mentioned then that the property market will not remain depressed indefinitely. In a similar vein, I am confident that the current price appreciation will not go unabated and it will correct in the near future.
The question is how can we tell when the Singapore property market is going to dip?
In my second book entitled Buy RIGHT Property — Taking the R.I.G.H.T. Approach to Property Investing in Singapore, I shared that my company has developed a proprietary index called the Ascendant Assets Index (AAI).

Figure 1: Ascendant Assets Index

The basic premises of the AAI are (1) there is a lead-lag relationship between the stock and property market and (2) we are able to tell how the property market is performing by analysing the correlation between the stock and property market. For example, in bullish (or bearish) market conditions, we would expect the correlation between the stock and property market to be high as prices are increasing (or decreasing) in tandem. On the other hand, we would expect the correlation between the stock and property markets to be low during turning points as stock prices, being more liquid, would diverge from the less responsive property prices.
So how is the market like now? Figure 1 shows the AAI for the recent quarter 2011Q1. From the figure, we can tell that the Singapore property market (shown in green colour) is presently in the strong growth stage with both STI and URA PPPI increasing in tandem. However, it is noteworthy that the AAI has dropped from over 90% to under 80%. Over the next few quarters, we expect the AAI to drop further. When the AAI falls below the 50% mark (represented by the dotted line), it signals a turning point as the stock market will be almost completely out of sync with the property market. It signals an overall change in underlying market sentiments and the property market would be expected to decline shortly after.
Figure 1: Ascendant Assets Indicator (2011Q1)
Conclusion
It is important to note that the AAI is only one tool to gauge how the property market is performing. There are other aspects to consider before making a buy or sell decision. Nonetheless, I have been asked by several prospective clients if it is a good time to buy properties. My personal view is that unless it is an essential purchase (e.g. buying a home to stay), I would stay out of the market right now. In fact, I had recently sold two properties to accumulate cash to prepare for the next market downturn.
As a parting shot, let me leave you with a quote by Warren Buffett that I often make reference to, "We simply attempt to be fearful when others are greedy and to be greedy when others are fearful". With the URA PPPI reaching a new peak in the last quarter, I can't help but to feel a slight sense of fear…
By Getty Goh, Director of Ascendant Assets, a real estate research and investment consultancy firm. Posted via www.Propwise.sg, a Singapore property blog dedicated to helping you understand the real estate market and make better decisions.
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Buy Right Property (at Propwise.sg)

Adjustment Bureau

Making Adjustments

Starring Matt Damon as a rising politician and Emily Blunt as a ballerina. The Adjustment Bureau is a love story with a bit of thriller and sci-fi thrown in. They play a lovestruck couple blocked from controlling their destiny when the agents of Fate conspire to keep them apart. Fate comes in the form of mysterious hat-wearing agents – the Adjustment Bureau – who resemble extras from Mad Men.

The action zips around New York, particularly in one pulse-pounding chase sequence that sees Damon race from the diamond of the New Yankee Stadium to the Statue of Liberty in a matter of minutes.

Now for my own input: It was an incredibly romantic show. Have you ever met a girl/guy you thought was meant to be with you? You met under some strange circumstance, like in a toilet (one of you ain’t supposed to be there). Locked visuals and feel that tingle in your body. You broke into conversation, exchanged some jokes and left. In American culture or in the movies, you kissed within 10 minutes of meeting each other.

Then somehow, you bumped into each other again in a bus. You had a fantastic exchange of conversation for the next 20 minutes. But the “Adjustment Bureau” just wouldn’t let you both be together. That’s because you were made for greater things and being with her/him will “divert” you from the path you were meant to travel. What if being with her will ruin her career aspirations? If you love her, would you sacrifice her career and yours just to be with her?

It’s a tough choice. I know it may never happen to me because first, I’m probably not meant to run for the Sennate in the US or for MP in Singapore, or that I’d ever meet the “Adjustment Bureau”. But I’ve probably experienced being with someone I love that will influence me the negative way. For example in this movie, Matt Damon was running for office; a logical, over-achiever. Blunt was a ballet dancer with no respect for rules, who let her emotions dictate her actions.

I love my wife very much. She’s family to me. She’s my pillar of support, the beacon of hope when I get battered and bruised by work, by the stock markets, by life. Her gentle touch calms me and tells me that everything’s gonna be alright. She is my only family, because I am not close to my parents. Never was. Her family showed me warmth that I’ve never experienced before. With her beside me, I can trust the world more, I feel more secure. She is the world to me.

However, while she doesn’t influence me the wrong way, she is a bit like Blunt’s character in the movie. She’s a little emotional, a strong lover for the arts. On the other hand, I’m a logical guy. Someone who loves to beat another in chess. I’m very competitive. I get frustrated if things don’t go according to my ideal vision of the world. I want to change the world, right every wrong. She forgives the world for all its flaws. She has a very kind though and tries to help the world in her little ways. I think of grand plans, schemes, strategies to change things.

In my opinion, it’s a match made in heaven. However,  In my former church, Wesley Methodist, a pastor who looked like Kung Fu Panda, by the initials of DT, told us our match was made in hell. It would never work out. That was way back in 2009 July. He even spoke about divorce and why we should never contemplate divorce in my wedding day. Before that, we had trouble getting married because not many pastors wanted to marry us in Wesley. It was the straw that broke the camel’s back. I wasn’t going to a church that puts me down. When someone tells me I can’t do it, I’ll put in 10x more effort to prove that I can.

Here I am DT, still married, still loving my wife very much. I’ll bet she loves me just as much and we are happier together than ever before. Wesley Methodist, You of the Adjustment Bureau. I don’t know what PLAN you have, or by what measure you took of us, but you’re dead wrong. I’m going to prove to you, that 5 decades later, when many of the wedding ceremonies you’ve conducted for those rich Beverley Hills couples whom you suck up to failed, we’re still together.

I have Grit, I have Strength, I see the BIG Picture, I have Gratitude. I’ll change the world for the better while you continue to write off couples like us.

http://en.wikipedia.org/wiki/The_Adjustment_Bureau

http://www.youtube.com/watch?v=wZJ0TP4nTaE