The Problem With Left Leaning Welfare States

In many countries where property prices are in a bubble: Cities of China, Singapore, KL and Iskandar Malaysia, most cities in Indonesia, New York, London, Sydney and Melbourne, there is greater need for social housing.

Recently, in a property convention in west London, there were many protestors against the greed of developers. They demanded affordable housing instead of luxury homes for foreigners and investors.

However, many welfare states in the west are practically bankrupt. The generous welfare payouts have left governments with insufficient funds to build affordable homes. In Asia, the governments couldn't care less and are too corrupted to build affordable homes, with the exception of maybe Singapore and Japan.

Income and corporate taxes cannot rise further, otherwise it will remove incentives to work hard and chase away businesses. Where will the funds come from?

When people in the west want affordable homes, they will have to be prepared for much less welfare payouts, less dependence on the state for pension. In fact pension funds should be privately run and not underwritten by the government.

Another mistake made by western governments is to rent out the affordable homes. People who own homes tend to work harder to pay off mortgages than people who rent. There is truth in the saying that a "home is a man's castle". once you own a home, you will work hard to make sure the mortgages are paid. Gradually when property prices appreciate, they will upgrade their homes, buy multiple investment homes. This is how people are rooted to the country and have a stake in the economic pie.

The malaise in Europe and increasingly in the US is an entitlement attitude. Most feel that it's the job of the government to make sure basic needs are taken care of. This is liken to a communist system that will never work.

Correction of Stock Markets...

Finally, we see a meaningful correction. I was hoping the S&P500 could drop over 10%, bringing the PE below 17x. It look as if this correction could last longer because:

1. The VIX Index rose to over 26. This is the highest since Sep 2011, when S&P500 corrected 15% and Asia ex Japan over 20%.

2. The macro picture is not good: the US Treasury 10 year yield dropped below 2%, indicating deflation ahead. German 10 year bunds fell below 1%. Oil prices dip below USD85 bbl. The yield curve for most large economies are largely flat.

3. Eurozone is entering into its third recession in six years.

4. China has a huge property bubble threatening to blow over. The evidence of China's slowdown can be seen in iron ore prices which dipped below USD85 mt.

We are in a slow growth environment. The PE ratios for most markets should not be at 17x, it should be closer to 14x. But the artificially low interest rates made money too cheap for speculation. It could be very challenging wen rates finally rise.

In my model, it shows several countries sectors as BUYS:

1. H Shares.
2. Russia (I'd wait for the charts to show a true turnaround. If you use the 3 month central bank rate, the yield curve is inverted).
3. US, European and Asian banks.

Several sectors are ready for dollar cost averaging:
1. Global equities (this is why I'm still positive on global equities, not getting out of my balanced funds).
2. Mining equities (I would not buy now, in fact cut loss on a rebound because China's building is bound to slow and Australia's mining output is still increasing).
3. Global tech
4. Energy stocks were battered recently. We could look selectively at those with natural gas exposure.
5. American home builders.

Now there is a huge list of countries / sectors that are a SELL:
1. Asia x Japan (this is due to the negative earnings recently. I'd wait a while before being concerned.)
2. Emerging markets (same as for 1).
3. Latin America. Rich valuations. Inversion of yield curve.
4. Thailand. Rich valuations.
5. Indonesia, Vietnam, Philippines, Korea.
6. Global real estate. It's a bad time for Asia's real estate especially, with govt clampdowns and bubbles deflating.
7. African and Middle Eastern markets.

On the whole I believe this is a very disjointed market, much like the 1990s..

1. For the developed countries that are not mining dependent, the bull run ran unabated from 2009 to now.
2. For Eurozone, it was pretty much choppy after 2011, the Euro crisis.
3. For North Asia, our fortunes followed China's and the resource countries, which saw the bull run end in 2011, before falling over 40%. They have just bottomed.

For many Asia centric investors and those who believed in the resource and Super Cycle bull shit, I believe their performances would have paled in comparison to those who simply bought US stocks.

What to make of the future

The rally will not run for over 24 months. Here are the scenarios:

30% probability
1. Economy recovers, inflation is benign, oil hovers around USD80 bbl. We should see the bull rally continue for another 24 months. Interest rates in the US will rise as expected in mid 2015. After several hikes, real estate in Asia will creak and drop sharply in 2016.


50% probability
2. Economy sputters. Inflation overs between 0 - 1% in Europe and the US. Oil falls to between 50 - 80. Iron ore falls between 50 - 80 mt. Under such a circumstance, which I believe is highly likely. Can you imagine what will happen to the corrupt middle eastern countries that run such a huge budget deficit that they rely on oil to be over 80 to balance their budgets? They will need to invest in other industries that create jobs. There will be less focus on idealism and religion. The fuel that feeds ISIS may slowly dry up. Shale gas output will slowly reduce our dependency on crude oil.

Of course the mining countries will continue to be in the doldrums. Australia, Indonesia, China's mines will be in trouble as they will find it uneconomical to run.

US Fed may keep rate at zero until end of 2015. Bonds will rally. Stocks will be volatile, with little returns. Only China's stock markets will recover as valuation recover slowly from rock bottom. The housing bubble worldwide will run out of control. When the Fed finally hikes, all will come tumbling. Stock markets should tumble within 18 months.

20%
3. Deflation worldwide. Europe cannot get its act together and it will be a lost decade for them. The US' growth is curtailed. China's property bubble unravels as their export market slowdown is not offset by domestic consumption increase.

we could see the end of the market rally within 12 months.

Equities Weekly: Risk Aversion Continues to Grip Equity Markets [13 Oct 14]

Equities Weekly: Risk Aversion Continues to Grip Equity Markets [13 Oct 14]

iFAST Research Team October 13, 2014

Equity markets around the world continued their decline over the week ended 10 October 2014, with the MSCI AC World index incurring a -3.26% loss. With risk aversion gripping the markets, developed markets generally led the losses – all of them were in the red when the week ended. Headline US equity indexes like the S&P 500 index and the Nasdaq 100 index fell by -3.73% and -4.47% respectively, while the European equity market (represented by the Stoxx 600 index) fell by -3.67% over the week. Over across in Japan, Japanese equities (as represented by the Nikkei 225 index) declined -1.47%.

Emerging and Asian markets as a whole held up slightly better than their developed counterparts, with the MSCI Emerging Markets index and the MSCI Asia ex Japan index falling by -1.35% and -1.48% respectively over the week. In East Asia, the Korean equity market (represented by the Kospi index) incurred a -2.65% loss, while Taiwanese equities fell by -1.84% over the week. Meanwhile, Hong Kong’s Hang Seng index declined slightly by -0.51%, while China’s HSML 100 index declined by -0.74%. Continuing its recent resilience over the past few weeks, the local Chinese equity market held up amidst the decline in global equity markets worldwide, with the CSI 300 index and the Shanghai Composite index inching up by 0.64% and 0.45% respectively. In Southeast Asia, Malaysian, Thai and Indonesian equities incurred losses of -1.77%, -1.07% and -0.56% respectively, while the Lion City’s STI index incurred a -0.90% loss.

Brazil was the top performing equity market under our coverage over the week, with the Bovespa index rallying by 3.54% over the week. Gold prices inched up by USD 32 per ounce, posting a gain of 2.04% in SGD terms over the week.
[All returns in SGD terms unless otherwise stated]

Investors may refer to Market Valuations as of 10 October 2014 for more details.

Europe: German Industrial Production Contracted in August
Following an upward revised increase of 2.7% on a year-on-year basis in July, German industrial production posted a contraction in August, contracting -2.8% for the month, missing consensus estimates of a -0.5% decline. On a month-on-month basis, industrial production fell sharply, falling -4.0% in August following a downward revised growth rate of 1.6% in July with consensus forecasting a -1.5% contraction. The month-on-month reading of industrial production marked the sharpest contraction since January 2009. With PMI manufacturing in contraction territory for the first time since June 2013 indicating business activity contracted, and factory orders posting negative growth figures in August, industrial production in Germany is expected to remain weak.
 Japan: Machine Orders in August better than expected   Core machine orders fell -3.3% year-on-year in August, down from a prior 1.1% increase and came in better than expected – falling less than the consensus estimate of a -4.9% year-on-year decline. On a month-on-month basis, machine orders in August unexpectedly increased by 4.7%, increasing for the third consecutive month and beating consensus estimates of a 0.5% month-on-month increase. Following the official release of the data, the Japanese government’s assessment of machine orders has been raised to a “moderate recovery” from the prior statement of “fluctuating trend.”

Greater China: Chinese HSBC PMI decline slightly in September, Taiwan’s exports weaker than expected
China’s HSBC purchasing managers index came in at a reading of 52.3 in September, falling by 0.5 points from a prior reading of 52.8. The latest data reflects that China’s economic activity expanded for a fifth consecutive month, but the growth rate of manufacturing output fell to a four-month low. However, companies are still optimistic on the business outlook, with 31% of interviewed companies expecting an expansion in business activities over the next one year. In the near term, with downside risks in the economy, monetary and fiscal policies are expected to be kept accommodative, which may help to support the 7.5% growth target.

Over across the Straits of Taiwan, Taiwan’s exports rose by 4.7% year-on-year in September, down from a prior 9.6% year-on-year increase and missing consensus estimates of a 8.5% year-on-year increase. September’s data also marks the slowest exports growth rate in 3 months. While growth continues to be supported by electronic products (which makes up the majority of exports), lower than expected exports for other products affected overall data. As expectations run high for the US economy to recover steadily, should China’s economy follow suit, commodities exports may see an uplift, although an uncertain outlook for Europe may negatively impact the country’s exports.

Southeast Asia: Malaysia’s exports improved in August
Over in Southeast Asia, Malaysia’s exports improved in August, posting a 1.7% year-on-year gain, higher than the upward revised 0.8% year-on-year gain in the preceding month. The export data also came in significantly better than the -1.4% year-on-year decline forecasted by consensus. Exports were boosted mainly due to the expansion of the exports growth for liquefied natural gas and electrical and electronic products, with the former posting a 3.8% year-on-year growth in August after a hefty -22.9% contraction in the previous month. Exports growth for electrical and electronic products (which accounted for 33.7% of total exports) also posted a 3.7% year-on-year gain, after a -1.0% slump in the preceding month. Moving forward, while exports growth is unlikely to register results as seen in 1H 2014, exports growth is expected to remain sustainable and supported with the gradual recovery of global economy.

Australia: RBA leaves benchmark interest rate unchanged
The Reserve Bank of Australia (RBA) left its benchmark interest rate unchanged at 2.50%, a move which was largely in line with market consensus. The central bank also confirmed its current guidance that “on present indications, the most prudent course is likely to be a period of stability in interest rates.” In its statement, the central bank commented that the decline in the exchange rate (the AUD) partly reflects the strengthening US Dollar, but reiterated that the currency “remains high by historical standard, particularly given the further declines in key commodity prices in recent months.” Australian policy-makers continue to call for a period of stable interest rates, and this could bode well for investors using AUD-hedged share classes to harvest interest rate differentials between the SGD and the AUD. But investors are reminded that they would be exposing themselves to currency risks of the AUD, which has been under pressure of late (see Idea of the Week: 3 Things To Know About Currency Hedged Funds [10 Oct 14]).