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Avoiding the Japanese Financial Disease

Avoiding the Japanese Financial Disease
The world has changed. Growth isn’t like what it used to be. And if growth isn’t readily available, that might be bad news for the investment world in general.
Japan may well represent the path of “change” we’re on globally. And that doesn’t look pretty.
Back in the 1970s and 1980s Japan was the home of innovative business models and progressive economic policies. These were seen as the cornerstone that propelled the country’s spectacular post-World War II growth story.
But now Japan only resonates long-term slump, economic mismanagement and huge government debt levels. After decades of unparalleled growth, Japan’s downturn took hold in the early 1990s when its asset price bubble burst and had a massive structural impact on the economy.
It wasn’t long before Japan became an economy where inflation, real interest rates and growth all sat close to or below the zero percent level. Efforts to resurrect the economy have so far failed.  
Unfortunately, there are signs the negatives within the Japanese story may be spreading.
Where does that mean for the rest of us?
The worry is that the global economy has caught the “Japanese disease” – i.e. secular stagnation and efforts to stimulate growth failing to have an impact. The key to whether it takes hold is whether global governments and central banks have learned the lessons and take a more proactive approach
Relying on interest rate cuts alone wasn’t enough to inflate the Japanese economy. Instead, the slowdown triggered deflation, with households delaying or cancelling purchases, expecting prices to be lower in the future.
The global economy is slowly moving towards the Japanese way. Central banks have spent years slashing interest rates and injecting more cash into economies. The aim was to stimulate growth in the post-global financial crisis world. But the rebound hasn’t materialized and inflation remains too low and moving towards deflationary levels.  The European Union is a particular worry, as consumer prices continue to fall.
Low-growth trap
The Organisation for Economic Co-operation and Development (OECD, which promotes economic growth, prosperity and sustainable development) recently warned that the world economy is slipping into a self-fulfilling “low-growth trap.” In such a scenario, slow growth would become a norm that would be hard to escape from.  
How did we get here?
Demographics, the explosion of debt globally and the disparity in wealth between the rich and poor are all part of the story. Low interest rates are also a natural consequence of too much government borrowing after the financial crisis. Essentially, 2008-09 changed a lot of things that we haven’t been able to reset.
Nowhere to hide
One issue trouble now is that growth is slow everywhere and no one region is strong enough to bail the others out. For some context, before the global financial crisis, over the 1980 to 2008 period, world GDP growth averaged 3.5%, according to economist Stephen Roach. That compares with 2009’s mere 0.028% increase and its later weak rebound.
Global authorities have also been slow to act. For years Japan resisted the restructuring and structural changes that might have supported a rebound. Instead, the economy spiraled lower. Prime Minister Shinzo Abe’s recent three-pronged attack on reviving the economy looks set to only have a limited impact.
The problems are spreading
Symptoms of the Japanese disease are evident across the world. Bubbles in the real estate and credit markets inflated US consumer spending after years of cheap credit. When the markets burst, the heavily indebted, savings-short households were badly affected.
Between 2008 and 2015, growth in inflation-adjusted consumer expenditures averaged just 1.5%, according to Stephen Roach. This was less than half the 3.6% pace of the preceding 12 years. Like Japan, the US now finds itself struggling to move beyond a low interest rate position with little in the way of sustainable growth to show for it. When rates do rise soon, hold your breath…
Europe is mirroring Japan even more. The continent has limped from one crisis to the next. The policy response has been quantitative easing and, now, negative interest rates, which is a similar approach to Japan. But the efforts to stimulate growth in the region and generate inflation have failed so far. The European banking sector is starting to look a lot like Japan’s – struggling with poor quality balance sheets. Tough decisions need to take place in Europe, even if the general public is resistant.
Emerging markets aren’t much help at the moment either. The resource-rich economies of Russia, Brazil and the Middle East are feeling the impact of low commodity prices. China’s slowdown also isn’t helping. 
This has huge implications for investors. The Japanese stock market is less than half the value of its 1989 market peak after its struggles. The fear is that if the disease does spread this could signal tough times ahead for global stock markets.
What can policymakers do to counter the threat?
How can these countries put themselves on a better footing?
For the US that may mean pushing the general public to reduce household debt and increase long-term savings. In Europe, banking industry reform and a coordinated government response look essential.
China needs to find ways to get its population to spend more as it reshapes itself into a consumer spending-led economy. The country also needs to address overcapacity in industries, such as the steel and cement sectors, which is driving deflationary pressure.
Japan needs to find ways to remain productive with a rapidly aging society and declining workforce.
Ultimately, a strong and coordinated policy approach to structural change could be the only answer. The OECD believes there has to be “collective action across economies to raise public investment in projects with a high growth impact would boost demand and improve fiscal sustainability.”
Left untreated, there’s a danger the Japanese disease becomes ingrained in our biggest economies and potentially infects everywhere. If that does happen, expect stock markets to struggle globally.
Shares like growth, not stagnation. In that environment, safe havens like gold will continue to be a popular home for cash.

Is Genie Energy Ready To Pop?

With great risk comes great reward. The truly great investors understand the risk/reward ratio and aren't afraid to take a calculated chance. How do we mitigate that risk? We study. We research. We gather like squirrels collecting nuts for winter in the hopes we can weather the storm when everyone else panics and pull a decisive victory out of thin air.
So what interests me about GNE? I am by nature a risk taker. I am not, however without caution when I need it. Even an old paratrooper like me knows to clip on a reserve pack when I jump out of a C130 at low altitude. Some investments are exactly like that. Ask anyone who invested right before SIRI dropped back during the bankruptcy days. Lucky for many of us at that time, we formed a support group of sorts on several websites. I managed no fewer than three of those forums at one point starting with the old SW, Radio Wars, Stock Shock crowd. Several of those investors had iron constitutions and turned .06 shares into substantial profits on the rebound. I am not saying GNE will do exactly that, what I am saying is that conditions are primed for a surprise.
Let's look at the basics:
The Strategic Advisory Board for Genie is not a list you won't recognize. Do you think that's a coincidence? Do they know something you and I don't? Sometimes the best thing an investor can do is follow the money. Who has taken interest in an investment and who has already done the risk/reward calculation. Let's throw a few names out there. Let's see who you recognize within a millisecond of reading my next words.
Richard Cheney (yes THAT Richard Cheney) 46th Vice President of the United States Rupert Murdoch - Founder and Executive Chairman of News Corporation, one of the world’s largest diversified media companies. Mary Landrieu - Former U.S. Senator from Louisiana Bill Richardson - Former Governor of New Mexico Jacob Rothschild - Chairman of the J. Rothschild group of companies and of RIT Capital Partners plc. Chairman of Five Arrows Limited. Michael Steinhardt - Wall Street investor and Principal Manager, Steinhardt Management LLC. Dr. Lawrence Summers - Charles W. Eliot University Professor and President Emeritus at Harvard University. R. James Woolsey - Former Director of the CIA Do I have your attention yet? Imagine me knocking on your computer screen from the inside out. Pay attention.
Now that we have the ice breaker out of the way let's look at another thing we love here at kingofalltrades.com. A chart. Yes it's time for the charts. We love to dissect them, flip them upside down, study them, and in my particular case I love looking at the long-term charts while everyone is hypnotized by the short term and misses the bigger picture.
So at a quick glance a pattern seems imminent.

I don't want to say you are blind if you don't see it, but I will if necessary.
With potential energy reserves that could tip the scales in Israel's favor dramatically in the coming years, that list at the top of this article is likely playing the long game. They are titans. My own opinion is that there will be money made on the next pop. Barring a surprise crisis beyond the chaos now. In the long term? I would bet those you see above have already set themselves up to laugh all the way to the bank.
Disclosure: I own shares of GNE as part of a balanced portfolio. All investors should do their own due diligence before investing in anything including stocks. Please consult a professional investment advisor if you are uncertain or wish to gain a better sense of the risks should you choose to invest. As with any investment I recommend you have a plan and only invest once you have completely gained an understanding of the effects of your investment.

Another BRIC Wall?

"Both from the standpoint of stocks and bonds, an investor wants to go where the growth is." Bill Gross
The trouble with buying into hot investment themes is that sometimes we find out too late that the idea isn’t so hot anymore. And that seems to be playing out with one of the more fashionable concepts over the last decade or so: BRICs.
Back in 2001, Goldman Sachs strategist Jim O’Neil wrote an investment piece entitled “Building Better Global Economic BRICs”, which championed the investment potential of Brazil, Russia, India and China (or “BRIC” for short). Despite the fact that the four countries from three different continents are shaped by very different political systems, growth dynamics and even national sports, they were viewed by many as one homogeneous story. In fact, O’Neill was trying to represent the broader fast-growing, heavily populated emerging markets space. It reflected what was seen as a shift in global economic power away from the established powers to a new bloc. Little did he know the true impact of his acronym.
Some commentators added South Africa to the party to form “BRICS” - and you could as easily have thrown in the likes of Indonesia and Vietnam into the mix – as it was really a reflection of the outlandish growth dynamism seen within the emerging market space in the new millennium, aided later by the cheap money of quantitative easing.
And the story seemed to play out. Investors jumped into BRIC funds, growth boomed and investment into these parts of the world soared. It was no coincidence that these countries were also invited to host some of the major global sporting events for the first time – the FIFA Soccer World Cup in South Africa in 2010, Brazil in 2014 and Russia in 2018; the Summer Olympics in China in 2008 and in Brazil later this year; the Winter Olympics in Russia in 2014 and China in 2022.
The whole thing’s been like a coming of age movie. And as with any of these things, you get to see the growing pains in full flow. 2015 and 2016 have reminded investors that these markets still have a lot of growing up to do. Last summer China’s stock market implosion came under the spotlight. Trying to sustain 7%+ per year GDP was always going to be a tall ask, particularly when your government is looking to develop a brand new growth model based on consumer spending rather than the investment and exports one that had served you so well in the past. Unfortunately, the fallout from this has left many investors questioning whether these kinds of markets deserve their attention.
And it hasn’t been a great time for these countries of late. While India has held up relatively well, the economic environment has significantly impacted many of the leading emerging markets countries. Collapsing commodity prices have had a severe impact on Russia, Brazil and South Africa. As much as these countries have grown their presences on the global stage, they still have classic emerging market sensitivities to counter – too heavy a reliance on natural resources in their cases.
And when growth slows, the spotlight falls back onto how well the country is being run. In 2016 we’ve already seen calls for the impeachment of the presidents of both Brazil and South Africa, as accusations of corruption, money laundering and the misappropriation of funds hang heavy over both heads of state. Russia is once again getting used to its status as an international pariah – whether that’s over the country’s involvement in Syria and the Baltics states, or allegations of state-sponsored doping of its athletes. None of this has been good for their stock markets or provided peace of mind for investors still buying into the BRICs concept.
What all of this shows is that emerging markets still have risks. Plenty of risks. But does that mean investors should run a mile and stick to developed markets? No. Just looking at Asia, some 60% of the world’s population live in the region, with China and India accounting for 37% of the world’s numbers. The fastest growing consumer markets for everything from champagne to Gucci bags can be found in emerging markets. People here are still building lifestyles. They are new consumers. They are still emerging. And while there is always the argument for investing in some of these regions through companies with heavy exposure to them, it’s never the most “honest” way to approach emerging market exposure. It always feels like you’re missing out on some of the ride, both up and down.
The risks are certainly there but so are the returns over the longer term. That’s why investors get excited about these types of places in the first place. Given the global growth concerns and where we are with the commodity cycle at the moment, today may not be the best time to jump into some of these markets. But that time will come and these markets will come again.

Hubble Bubble, Oil and Trouble

“We really can't forecast all that well, and yet we pretend that we can, but we really can't.” Alan Greenspan, former Chairman of the Federal Reserve Bank.
It wasn’t meant to be like that. A new year and a fresh new start was supposed to be the narrative. The Fed starts its rate rising cycle into an unassuming, benign environment. Well, it seems stock markets around the world simply haven’t been listening.
It was only months ago that we were celebrating multi-year highs across a number of global indices. Now all the talk is about guessing which stock market will next fall into bear-market territory. Whether it’s China, the UK, Japan or Australia, all regions have markets at least flirting with the 20% decline from their peaks that would define such a slump.
And the negative headlines continue: “India hits a 20-month low”, “The S&P 500 declines to a 21-month low”, “Hong Kong’s Hang Seng Index falls to its lowest since 2012.” It’s been a bit of a bloodbath, laced with a margin call/liquidation feel about it. VIX, the “fear index”, has jumped over 50% this year. Throw in the hits to high yield currencies and commodities, and a lot of investors are feeling a little nervous right now.
So what’s driving this? In a nutshell, wherever you live in the world and whatever your geographic market bias, it’s back to stressing how much we live in an interconnected world.
One of the biggest headline grabbers of late has been the collapse in the oil price. The West Texas Intermediate (WTI) grade has fallen more than 25% so far this year and now sits below $27 a barrel for the first time since 2003. 18 months ago we had $100 oil and all was right with the world.
The trouble with what's happened with oil of late is that it encapsulates a number of different concerns: economic growth, politics, geopolitics, and corporate debt.
On the global economic front we’ve got China’s slower growth story continuing to unnerve investors. Whether the data coming out of the country can be trusted remains open to debate. Critics only see exaggeration. Nonetheless, the 6.9% growth figure China released for 2015 did fall short of 7% government estimates, was below the 7.3% for 2014, and marked the slowest rate in 25 years. Analysts forecast 6.5% for 2016, which wouldn’t be much of a problem if the rest of the world hadn’t become so reliant on this economy to take up the global growth slack. And a slower-growth China also means lower demand for oil.
Not only is the oil space being hit by a weaker demand environment, it’s also facing a new wave of supply coming onto the market. In the US, Congress voted in December to lift a 40-year ban on crude oil exports as part of a broader spending bill that averted the possibility of a government shutdown. The legislation will finance the government through September 2016. The political compromise is proving to be unfortunate timing for the oil market. Who knows what the changing of the presidential guard in the US this year will do for future energy policy?
Events in the Middle East have also added to the oversupply dynamic. Diplomatic relations have become even more strained than normal between Iran and Saudi Arabia, the world’s largest oil producer. Unfortunately, this is also playing out messily when it comes to oil. US and European Union sanctions have recently been lifted on Iran, restoring the country’s access to world markets. With the country planning to immediately ramp up oil production by 500,000 barrels per day, it aims to boost output by as much as 1 million barrels within a year. Rather than trying to support oil prices by cutting output, Saudi Arabia seems set on maintaining levels and market share to nullify the Iran threat. So for expediency’s sake, Saudi Arabia appears happy to keep oil prices low to hurt Iran. That’s how it appears anyway.
And then there’s the issue of debt. In the post-financial crisis world, banks had to rebuild their loan books with safer, more reliable borrowers. It was time to step away from the consumer and target corporates. What could be safer in a low interest rate environment than energy companies looking to expand production into new growth markets with the oil price at $100? Well, it’s become a bit of a perfect storm – interest rates are rising, the strong dollar is impacting the value of overseas earnings, emerging markets aren't emerging so much and we all know what’s happening with the oil price. So this is could become an earnings concern for coming quarters – will banks struggle with escalating defaulting loans from energy companies?
So investors have plenty to think about. With the beauty of hindsight a number of commentators have come out to say that the Fed shouldn’t have raised rates at all in December. The counter to that view is that markets are telling a different story to the broader economics, which really aren’t that bad. Yes, China’s expansion has slowed but that’s not new news, while the US has been showing steady if unspectacular growth.
But this is very much a sentiment-driven market. And sometimes sentiment can make certain scenarios self-fulfilling. Understandably money is flocking to gold and other safe havens. There’s also plenty of cash sitting on the sidelines, waiting. Who knows whether in five years’ time we’ll even remember any of the current narratives. For now, though, it’s not a time to panic. Keep calm, carry on and make the most of the cheap flights the oil price should give us.
Teaser Paragraph:

“We really can't forecast all that well, and yet we pretend that we can, but we really can't.” Alan Greenspan, former Chairman of the Federal Reserve Bank.

It wasn’t meant to be like that. A new year and a fresh new start was supposed to be the narrative. The Fed starts its rate rising cycle into an unassuming, benign environment. Well, it seems stock markets around the world simply haven’t been listening.


Another Year, Another Dollar

“Cheers to a new year and another chance for us to get it right.” Oprah Winfrey
It’s December already and the year seems to have gone by in a flash. It doesn’t seem that long ago that excessively bullish sentiment was front and center of our minds, even if a US recovery was still uncertain and the noises out of Europe were worrying. How quickly we move on.
Investors will be catching their breath after another uncertain year and the “will they, won’t they?” Fed deliberations. In September the VIX Index partied like it was 2011 all over again, the last time the volatility measure rose above the 40 level. That time we had the European sovereign debt crisis, this time we had China. We live in an interconnected world.
As 2015 comes to a close it’s time to look back on another memorable year for the markets - memorable in part because we have finally put to bed the “Great Equity Market Bull Run” that blossomed out of the ashes of 2009. Yes, the Dow Jones Industrial Average hit an 18,351 record high back in May, but the market swings experienced in the second half of the year suggest we shouldn’t expect the market to oblige with a straight line trajectory in 2016.
So what have we learned?
If you weren’t too familiar with the Chinese stock market before this year, you’re certainly more aware of it now. Never has a 7% annual growth rate (or there abouts) turned out so messily for a country. The global market rout seen in August tells us that. As Chinese authorities battled to prevent the boom-bust behavior spilling into the real economy, so much wealth was created and so much destroyed in so short a period of time. It’s the meeting of free market principles with a managed economy. The experiment remains a work in progress. China’s increasing presence on the world stage, though, means investors have no choice but to monitor events there.

And China’s slowdown and subsequent government interventions have had huge ramifications across the board: commodity prices have collapsed, hurting resourced-biased economies from Australia to Brazil to Chile. It postponed the Fed's rate hike decision in September. It sent emerging market currencies into panic mode. It even managed to take a bite out of Apple’s revenue as smartphone shipments in this key market for the company slowed. Shipments are forecast to grow about 1% in 2015, compared with a 20% increase in 2014 and 64% in 2013, according to market research firm IDC.

In case it escaped anyone’s attention, Europe remains a basket case. Even without the enormity of the migrant crisis – and 2016 doesn’t look like a year of resolution for this - we’re talking about a region with a central bank that began a $1.2 trillion quantitative easing program in March and is likely to do more. The Greek crisis is still, well, a crisis. Meanwhile, the shadow of terrorism once again loomed large though Islamic State-inspired atrocities. Add to that the unconvincing post-austerity recoveries that have fed voters frustration and lurches to the extremes of the political spectrum, and you can see why confidence is fragile. The region is set for a very different growth trajectory to that of the US and that’s playing out in interest rate expectations and euro weakness. The divergence in regional cycles isn’t great for investors.

Emerging markets were supposed to make up for the global growth where developed markets, and Europe in particular, were falling short. We were supposed to be embracing CIVETS (Columbia, Indonesia, Vietnam, Egypt and South Africa) as we tired of BRICs (Brazil, Russia, India and China) and milked the EM story further. Unfortunately, we've hit a pause button here. The EM space has showed signs of rolling over at a time that the US is showing signs of recovering. And having borrowed heavily in US dollars, a rising currency that will accompany rising US interest rates will continue to provide headwinds for EM. The threat of heavy fund flow out of these markets and into a US market of rising interest rates is a risk for 2016. Let the flight to quality begin.

Most of the smart money accepted the price of oil wouldn’t return any time soon to the heady days of above $100/barrel seen back in summer 2014. But while the setting for 2015 may have looked challenging with West Texas Intermediate grade oil at the $60 mark, who would have guessed we could end the year closer to the $35 level? The oil story is where the macro picture meets geopolitics, very little of which has been supportive.

The gold bugs have also gone quiet, for now at least. The commodity’s early-year peak of $1300/oz now looks a world away from $1066 now. The prospects of a rising interest rate environment ensured that plenty of institutional money departed stage left in recent months, leaving plenty of retail investors newer to the game with holdings significantly under cost price and effectively waiting on the next crisis.

Geopolitical tension and terrorism are now part of life. For good or for ill, the market doesn’t get so shocked by terrorist attacks any longer. The shooting down of a Russian passenger plane, the tragic November events in Paris, the San Bernardino attacks, and the Charlie Hebdo terror all shook us as individuals. But the market absorbed the events and moved on.

The consensus view for 2016 is broadly cautious so read that as expectations for another bumpy ride. The Fed’s rate normalization process, China’s growth narrative and Europe’s state of disrepair provide the backdrop. Let's also not forget the small matter of a US presidential election and that can polarize and impact market sentiment.
Suffice to say none of us have a crystal ball and most forecasts coming out now for 2016 will be proved wrong, at least in part. That’s not to say we shouldn’t listen to them but as investors we do very often have short memories. Before we know it we’ll be excessively bullish again. Let’s just see now how quickly we move on.
Teaser Paragraph:

“Cheers to a new year and another chance for us to get it right.” Oprah Winfrey

It’s December already and the year seems to have gone by in a flash. It doesn’t seem that long ago that excessively bullish sentiment was front and center of our minds, even if a US recovery was still uncertain and the noises out of Europe were worrying. How quickly we move on.

Investors will be catching their breath after another uncertain year and the “will they, won’t they?” Fed deliberations. In September the VIX Index partied like it was 2011 all over again, the last time the volatility measure rose above the 40 level. That time we had the European sovereign debt crisis, this time we had China. We live in an interconnected world.

When Interest Rates Rise

“History doesn't repeat itself, but it does rhyme.” Mark Twain
It’s pretty clear that a rising interest rate cycle will kick back into gear again soon. Rates may not move that far or that fast any time soon, but directionally the only way is up.
So how will it pan out for investors? It’s difficult to tell. Things really are different this time.
The US economic expansion has already lasted well beyond the postwar average of just under five years. As a result, we’re in pretty unchartered territory this time around, even if the scale of the recovery has been one of the weakest in that period (annual growth has been averaging 2.2% versus the 3.6% of 1991-2001).
This is also a monetary policy cycle shaped by QE, significant economic dislocation and a change in Federal Reserve leadership.
That’s one reason why investors have to tread carefully. It’s really not clear as to what impact interest rate rises will have - psychologically or otherwise - on a public still unconvinced that the recession is actually over and on an economy that hasn’t managed to stoke inflation in this recovery.
To get a sense of what it will mean for investors, there are a number of variables to consider. How fast will interest rates rise? Will rate rises choke economic growth? Will increases hurt credit conditions? Will they result in a divergent growth path for the US relative to other parts of the world? All these factors can have a bearing on how you put your money to work and whether risk assets are still the place to be.
But on a best-guess basis, and how asset classes have performed in the past, let’s randomly consider a few areas:
Gold. Stating the obvious, gold’s clearly lost its sheen. If crazy volatility in the Chinese stock market and a deadlock in Greece’s economic future weren’t enough to stop the commodity from plummeting to a 5-year low then who knows what will. Yes, it makes sense to build a position for hedging purposes at these low levels, particularly if rate rises lead to market volatility and more anemic economic growth. But don’t expect to see a bull market in the yellow metal on the scale that we experienced a few years ago. Relative to cash, gold just won’t look as appealing. Money in the bank will yield cash, gold won’t.
Bank stocks. Banks like and dislike higher interest rates. They like them simply because they are able to charge more for loans, while also attracting more cash from depositors. They dislike them because higher rates tend to lead to more defaults by those that can’t afford to pay that little bit extra. Net-net, they’ll see rate increases as a positive and a recent recovery in some of those names are starting to reflect that. Obviously, it’s also about making sure you get them at the right price as well.
Cyclical stocks. Historically, the likes of Consumer Discretionary and Industrial stocks have tended to do relatively well when rates have started to rise. The thinking behind this is that a rate rise is a direct reflection of a healthy economy and improving consumer confidence. The trouble this time around, of course, is that you still have a sizable slice of the population not yet convinced that the recovery is taking hold.
Property. How will higher rates impact? It depends. On the one hand, rising interest rates will equate to higher borrowing costs, building costs and delinquency rates, none of which are traditionally good for the industry. But if the pace of rate rises simply reflects robustness in the economy, then real estate, both in terms of hard assets and stocks, may well still look attractive, particularly if the first rate rises remove some of the speculative froth out of the sector.
Cash. We’re talking about savings and money market accounts essentially. It may not be the most exciting or sensible option over the longer term, but at the very least you will finally start to see a bit of a return on your Christmas money that has been sitting on your account doing absolutely nothing.
US dollar. Maybe a lot of this story has already been factored into the greenback, given that it’s been pretty strong against most currencies of late. But traditionally rising rates support a higher US dollar, which is also bad for the commodity sectors given their negative correlation to dollar. Conversely, for those economies that have currencies pegged to the dollar but don’t share the same economic outlook, maybe there’s reason to be cautious about them. An example of that is Hong Kong. While its currency moves in line with that of the US, its economy is far more attuned to the economic picture in China. And we all know that story’s been a mess of late.
Fixed income. Investors no double have already been reducing their long-term bond exposure while beefing up their positions in short- and medium-term bonds, which are less sensitive to rate increases than longer-maturity bonds that lock into rising rates for longer time periods. The lack of value in the shorter-term lower-yielding bond model is the downside to this strategy and anyone looking to keep exposure to this space should consider inflation-hedging strategies.
History can be a dangerous reference point for investors, particularly if extrapolated data is misinterpreted or followed to the letter. But sometimes it's the best guidance we've got available to us. So use it wisely.
Disclosure: I currently do not hold any positions in any securities mentioned. As with any investment, please do your own due diligence and only invest in any security based upon your own research and ability to withstand the risk to reward ratio. Investing in any security carries risk and market conditions can change rapidly.
Teaser Paragraph:

“History doesn't repeat itself, but it does rhyme.” Mark Twain

It’s pretty clear that a rising interest rate cycle will kick back into gear again soon. Rates may not move that far or that fast any time soon, but directionally the only way is up.

So how will it pan out for investors? It’s difficult to tell. Things really are different this time.

The US economic expansion has already lasted well beyond the postwar average of just under five years. As a result, we’re in pretty unchartered territory this time around, even if the scale of the recovery has been one of the weakest in that period (annual growth has been averaging 2.2% versus the 3.6% of 1991-2001).

This is also a monetary policy cycle shaped by QE, significant economic dislocation and a change in Federal Reserve leadership.

That’s one reason why investors have to tread carefully. It’s really not clear as to what impact interest rate rises will have - psychologically or otherwise - on a public still unconvinced that the recession is actually over and on an economy that hasn’t managed to stoke inflation in this recovery.


Emerging Markets to the Rescue?

“China is a sleeping giant. Let her sleep, for when she wakes she will move the world.” Napoleon Bonaparte
The thing is China isn't the only sleeping giant. It may be the biggest and most impressive story but there's a whole lot more. Part of the fallout of the ongoing FOMC deliberations about interest rates and recent events in China has been to bring emerging markets in general back into the spotlight. Ultimately, the whole space has a story worth hearing.
In terms of where we are now, the fear is that slowing growth in developed markets and an appreciating US dollar may pull down emerging markets. Emerging markets are hoping the Fed will postpone rate hikes for as long as possible, mitigating the threat of a massive exodus.
For a rate hike to have a positive impact on emerging market fund flows, the Fed would need to state clearly that it plans to proceed very slowly with raising its base rate going forward. But we can expect more volatility as a result of central bank policy actions and global growth concerns.
With volatility comes a lower risk appetite and an outflow of cash from riskier assets. But while we still hang onto every word out of a Fed governor and consider every economic data release emanating from China, it’s worth getting some perspective on what all this means for emerging markets.
Why are we interested in emerging markets anyway?
It’s basically about future growth. Economic, population, consumer demand, manufacturing capacity, resources. You name it. These countries are there to make up for where developed markets fall short. And for all the noise of late, emerging markets certainly isn’t all just about China.
In fact, the phrase “emerging markets” itself is a catchall for a number of countries with aspirations for developed status that don’t quite meet requirements on certain economic or structural metrics.
They don’t have to have any cultural or geographical commonalities. Simply aspirational. They are developing countries that are neither part of the least developed countries, nor of the newly industrialized countries.
As a term it’s a bit outdated and as a gauge for investment it can be misleading. For one thing, different organizations classify countries differently. Greece, for example, doesn’t yet make the emerging markets list for the IMF, but is grouped as such by MSCI and Dow Jones; Nigeria doesn’t make the grade according to some investment classifications but is viewed as an emerging market one by the IMF.
Recent market volatility saw all emerging markets tarnished by the same brush, despite some economies offering domestically-focused growth dynamics so are sheltered from much of the global storm. There are others like India very much on a reform path and should be rewarded rather than punished for their efforts.
Any other problems with investing in emerging markets?
One of the big issues for investors in these markets is liquidity. Recent months have seen plenty of capital flee these markets and no one wants to be stuck with an investment holding they can’t sell. With risk aversion comes a flight to quality, which usually means that US equities benefit.
Another problem is that it’s not always straightforward to play these markets. It’s all well and good looking at fundamentals but other issues can take precedent. For example, big political uncertainty in markets like Malaysia, Brazil and Indonesia can pose too big a risk relative to company fundamentals. Investors in these markets have also had to take the recent pain of currency adjustments, thanks in part to China’s currency devaluation.
And we can’t forget what’s happened in the commodity space with the collapse of metal and oil prices. Brazil and Russia, amongst many, have been hit hard. Yes, these overly-dependent economies are trying to transition themselves to less reliance, but this just means more unknowns in the short term, even if the longer-term story is more supportive.
And that’s the issue for China. Currency devaluation and lower government investment haven’t been welcomed everywhere. And the country’s deliberate actions to shift to a consumption-based model away from an investment and export one have brought market volatility. But no short-term pain, no long-term gain.
So do emerging markets make sense for investors?
With the right risk tolerance, asset allocation parameters and time perspective, the answer is “yes”. This is particularly relevant for those chasing alpha and outsized returns.
It’s about being strategic. For most people, the right investment vehicle would be a cheap mutual fund or an ETF (such as the iShares MSCI Emerging Markets ETF). But there are always pockets of opportunities for those willing to take a punt.
Certain markets, such as Sri Lanka for example, are less crowded by overseas investors. Because of this they are less researched and smart investors are better able to find value. And when foreign institutional money does get round to pouring into some of these markets, it brings with it more transparency but less of the easy money opportunities.
Another long-term positive is the recently agreed Trans-Pacific Partnership (TPP), a trade agreement between several Pacific Rim countries. This offers huge opportunities for the likes of Vietnam, whose GDP is forecast to be boosted by 11% over the next decade on the back of TPP.
And that’s the whole point. Think long term. Corporate balance sheets are far healthier than they were during the Asian Crisis of 1997. We’re seeing burgeoning middle classes in a number of these markets willing and very able to spend.
Consultancy firm Bain, for one, predicts double-digit luxury goods sales growth over the next several years in Africa. Meanwhile, Nigerians are consuming champagne at a faster rate than the fast-growth Chinese market, according to Euromonitor.
So if you are looking beyond a collective investment vehicle, look for quality local companies in the right markets with steady cash flow. This will take a bit of research. Alternatively, consider US stocks with high emerging market exposure, such as Philip Morris International (NYSE: PM), Caterpillar (NYSE: CAT) and even Apple (NYSE: AAPL).
Emerging markets are not just China. Risk today can be an opportunity tomorrow, so have cash on the sideline to put to work.
Disclosure: I currently do not hold any positions in any securities mentioned. As with any investment, please do your own due diligence and only invest in any security based upon your own research and ability to withstand the risk to reward ratio. Investing in any security carries risk and market conditions can change rapidly.
Teaser Paragraph:

“China is a sleeping giant. Let her sleep, for when she wakes she will move the world.” Napoleon Bonaparte

The thing is China isn't the only sleeping giant. It may be the biggest and most impressive story but there's a whole lot more. Part of the fallout of the ongoing FOMC deliberations about interest rates and recent events in China has been to bring emerging markets in general back into the spotlight. Ultimately, the whole space has a story worth hearing.

In terms of where we are now, the fear is that slowing growth in developed markets and an appreciating US dollar may pull down emerging markets. Emerging markets are hoping the Fed will postpone rate hikes for as long as possible, mitigating the threat of a massive exodus.

For a rate hike to have a positive impact on emerging market fund flows, the Fed would need to state clearly that it plans to proceed very slowly with raising its base rate going forward. But we can expect more volatility as a result of central bank policy actions and global growth concerns.

With volatility comes a lower risk appetite and an outflow of cash from riskier assets. But while we still hang onto every word out of a Fed governor and consider every economic data release emanating from China, it’s worth getting some perspective on what all this means for emerging markets.

China's Crisis and the World

So last week's sell-off wasn't just a simple one-time blip.
Yesterday the Dow Jones Industrial closed down 3.57% or 588 points. It could have been worse, having opened down 1,089 points. Across the world it felt like 2008 all over again. And it doesn't make good viewing against most technical analysis readings either, given the decisiveness with which the indices fell through their 200-day moving averages. Fear is back on.
The "Great Fall of China" was one newspaper headline, essentially highlighting that this story is very much about events in Asia rather than thoughts of a Fed rate hike.
Should this be a surprise? Not entirely. As highlighted in a number of pieces on this site (see: Don’t Ignore the China Market, Looking For the Next Investment Bubble, China’s Bubble Increasingly a Worry), China for some time has looked a concern. Even before the recent devaluations and even before the big Shanghai market sell-offs a few weeks ago, we had a collapsing housing market, investors overstretched on credit, an equity market overstretched on valuation, and major concerns about just how fast China is really growing. And as much as China is trying to manage the shape of its economic growth and the social evolution of its people, managing capital markets is proving to be a different kind of beast.
We live in an interconnected world and those commentators that simply looked at what the Fed was up to and even a few months ago were dismissive of the impact of China's closed capital markets on global markets, were guilty of still being lost in a financial media narrative that's traditionally US-focused. Clearly it's no longer just the US sneezing and the rest of the world catching a cold.
Things don't look great in the near term but we still have to have some context. China's growth story is a bit of a worry. GDP, PMI and an array of other indicators have shown us as much of late. But at the same time, it’s not as if China’s going into a recession. Far from.
The powers that be claim GDP growth will be 7% for the year; commentators suggest it’s more likely going to be closer to a 6.5-7% range. It's simply not going to be growing at the 8-10% that the rest of the world relied on to offset growth shortfalls elsewhere.
Was yesterday's sell-off a sign of herd mentality? Yes. That and computer's closing out of positions on the behalf of vacationing fund managers.
If you're playing the long game, days like yesterday could be healthy. It throws up cheaper stocks and new opportunities. There’s no need to chase a speculative biotech in this environment when you can probably get a decent return over time on a more boring General Electric (NYSE: GE), AT&T (NYSE: T) or IBM (NYSE: IBM) in this world.
And that's what investing should be about - getting assets at the right price. We should still expect a lot more volatility and a bit more stimulus out of China (after all, they have plenty of cash to step in with if they choose), particularly if this starts to look like a slow-motion crash. In the near term, at least, there could be more dark days to come. But the key is to look further out and the opportunities that days like this offer.
Disclosure: I currently do not hold any positions in any securities mentioned. As with any investment, please do your own due diligence and only invest in any security based upon your own research and ability to withstand the risk to reward ratio. Investing in any security carries risk and market conditions can change rapidly.
Teaser Paragraph:

So last week's sell-off wasn't just a simple one-time blip.

Yesterday the Dow Jones Industrial closed down 3.57% or 588 points. It could have been worse, having opened down 1,089 points. Across the world it felt like 2008 all over again. And it doesn't make good viewing against most technical analysis readings either, given the decisiveness with which the indices fell through their 200-day moving averages. Fear is back on.

The "Great Fall of China" was one newspaper headline, essentially highlighting that this story is very much about events in Asia rather than thoughts of a Fed rate hike.

Should this be a surprise? Not entirely. As highlighted in a number of pieces on this site (see: Don’t Ignore the China Market, Looking For the Next Investment Bubble, China’s Bubble Increasingly a Worry), China for some time has looked a concern. Even before the recent devaluations and even before the big Shanghai market sell-offs a few weeks ago, we had a collapsing housing market, investors overly stretched on credit, an equity market overly stretched on valuation, and major concerns about just how fast China is really growing. And as much as China is trying to manage the shape of its economic growth and the social evolution of its people, managing capital markets is proving to be a different kind of beast.


What China's Devaluation Means

Well, we’ve had a few more fun and games coming out of China of late. So what’s the big deal with the Chinese currency devaluations anyway?
It’s something that has to be put into the context of what else has been going on in the country. Essentially, it’s all about growth. A slower global and local growth story has meant less demand for Chinese products, which has led to a collapse in commodity prices.
Not entirely unconnected has been the crashing Chinese stock market and the fear that the public will stop spending domestically and reinforce the growth slide. In very basic terms the currency depreciation was to counter all of this, as well as maybe an attempt at getting ahead of the expected rate hike in the US.
Prior to the move, the strong yuan appreciation in real effective exchange rate (REER) term had put a lot of pressure on China’s exports. From June 2014 to July 2015, the yuan had appreciated in REER terms by 12%, mainly because of US dollar appreciation. Not a good look of you're a Chinese exporter.
Turning back to now, analysts are talking up the possibility for further currency depreciation. There’s no consensus as to whether this is the start of a sustained period, though Bank of America-Merrill Lynch anticipates 5%-10% depreciation in the next 12 months. And we shouldn’t be surprised if we see “competitive currency devaluation” in those low-cost manufacturing countries that compete directly with China, such as Vietnam. So the implications are far reaching.
There are plenty of different ways to look at what has happened in terms of the winners and the losers. Here are just a few:
So who’s it benefiting?
Chinese companies. Very broadly (and with plenty of caveats), Chinese companies stand to gain a competitive advantage against plenty of their international peers, as their goods become a little bit cheaper.
Chinese export trade. More specifically, while the impact is uneven, general consensus is that the Chinese export trade will see some support from the devaluation, principally benefiting those exporters with mostly Chinese production. Global earners but with local costs are the standouts. Most Chinese companies don’t fit this bill though. But if you do have production sites and cost bases in China and meaningful revenue exposure outside the country you’ll be happy.
Some US importers. Most US apparel companies purchase product from Chinese factories. According to Goldman Sachs, over the past 12 months 36% of apparel imported into the US came from China. The broker estimates that 60% of the costs are denominated in yuan while the remaining cost is denominated in US dollars. All things being equal, the first -1.9% move in the yuan equated to an average 40 basis points benefit to retailers’ gross margin.
Who isn’t so happy?
Those foreign companies exporting to China. You won’t be too happy if you were relying on China as your export market, given that demand for imports are expected to weaken further. Companies with higher sales exposure to China (assuming that transaction currency is based in the yuan) or are competing directly with Chinese firms will see a negative impact as the depreciation will improve the competitive strength of Chinese companies against others. And international companies with China operations might feel a bit of pain as well.
Luxury goods sellers. China had become the land of milk and honey for global luxury goods makers looking to get a piece of the brand-happy, growing middle class. Unfortunately, making expensive goods even more expensive isn’t what a more cautious Chinese consumer is looking for. Also, if you’re Gucci and relied on Chinese travelers buying your handbags when they headed abroad, you may also be disappointed given the weaker consumption power.
US Tech stocks. It’s not totally obvious as to how currency volatility can affect a lot of US sectors. Hedging strategies and smart accountants can put paid to that. But purely based on an exposure perspective, information technology stocks are the most exposed to China within the S&P 500, with 10% of revenues generated in the region. This compares with less than 2% for Industrials and the Consumer sectors, two other areas that are big on exporting.
Chinese companies with high imported costs or foreign-currency debt. It’s not great for all Chinese companies. If you’re a company with high levels of imported costs or are a company with high exposure to foreign-currency-denominated debt and high borrowing (like some of the airlines there) you won’t be very happy.
A lot of emerging market countries. Whether we talking about Russia, Indonesia or Brazil, the currency story is a bad one, particularly those countries with big commodity price biases. It’s not great being a US company exposed to this dynamic either.
So it's been a busy week for a lot of investors that never really paid any interest in currency movements. But given the way that the authorities handled the whole thing, it's still "watch this space".
Teaser Paragraph:

Well, we’ve had a few more fun and games coming out of China of late. So what’s the big deal with the Chinese currency devaluations anyway?

It’s something that has to be put into the context of what else has been going on in the country. Essentially, it’s all about growth. A slower global and local growth story has meant less demand for Chinese products, which has led to a collapse in commodity prices. Not entirely unconnected has been the crashing Chinese stock market and the fear that the public will stop spending domestically and perpetuate the growth slide. In very basic terms the currency depreciation was to counter all of this, as well as maybe an attempt at getting ahead of the expected rate hike in the US.

Making Sense of US Reporting Seasons

"There are lies, damned lies and statistics." Mark Twain
We’re in the middle of a US quarterly reporting season once again. For many, the company releases are just noise – the headlines make sense but the rest of the information doesn’t mean a great deal. For others, the season provides a decent insight into corporate America, providing a good basis (or not) to invest in the market. To get the most out of the season, it makes a lot of sense to understand some of the dynamics within the quarterly releases. Here are a few tips on what to look out for:
About two-thirds of companies beat earnings expectations. When I was actively analyzing and recommending US stocks in a previous life I always found that the number of companies that beat forecasts tended to veer somewhere between around 62-68%. So invariably the vast majority of companies will better analyst earnings forecasts. Perhaps that says a lot about the cat-and-mouse game of managing expectations, given that companies would already have provided guidance to the market. Regardless, don’t be surprised if, say, 65% of the S&P 500 have better-than-expected numbers at the end of the reporting period. The key, however, is finding out which sectors are materially above and below this 65%. And by how much they beat earnings on average. Depending on the reason behind the misses or gains, these are the sectors that could be worth considering or avoiding.
Don’t get sucked in by the headline figures. Apple reported that it sold 47.5 million iPhones during the last quarter. In absolute terms, that’s a hell of a lot of smartphones. But relative to market expectations it was pretty disappointing and part of the reason for the sell off in the stock after the results. We always have to take on board what the market is expecting and how the company’s numbers stack up against that. Sometimes the market gets ahead of itself, in terms of expectations, and a sell off can act as a rebalancing mechanism.
Don’t forget the outlook statement. A company releases its results after the market closes. It significantly beats market expectations on the revenue and earnings lines, so you put in a buy order for the following trading day. The next day, however, the stock sells off dramatically. You realize that you hadn’t taken note of the outlook statement. Seasoned investors don’t tend to make such mistakes. But we can all fall victim. One time as a junior analyst I provided a quick upbeat précis to internal portfolio managers on the results of ICI, a British chemical company, stating that the numbers were pretty decent. Satisfied, I headed off to the analysts’ meeting that followed the release. By the time I had returned to the office, the shares were 7% lower. Somehow I had missed the profits warning embedded in the outlook statement of the release. It was a basic error and a chastening experience.
Take note of whisper numbers. There are official expectations and then there are “whisper numbers”, essentially off-the-record earnings and revenue expectations for a company that circulate within Wall Street. Not all company results have them, but if they do exist you should realize that the market is factoring those in as well. So if the results smash through what you know are the official market expectations yet the stock doesn’t move much, see whether it’s because the results have simply only met the whisper numbers.
Keep an eye on the balance sheet, particularly in a downturn. Earnings are important. Fundamentally, they make companies tick. But don’t just focus on the income statement, however good the numbers look. If the economic cycle is working against a company, and it’s coming under debt or cash flow stress just to meet its numbers, be wary about investing. We all look first to a company’s earnings but we should also be looking at how efficiently it’s earning.
Extrapolate, up to a point. Companies within the same sector tend to report in clusters. Banks, for example, tend to be amongst the first to report, while energy companies tend to be towards the end of the season. So if you see good numbers out of JPMorgan, does that mean Goldman Sachs will have similar results a few days later? Not necessarily. You may certainly be able to extrapolate trends in the trading and investment banking space, which could have an impact on Goldman. But JPMorgan’s mortgage book, for example, will be far less relevant for Goldman's earnings story. As it turned out, JPM beat earnings expectations by 7%, while Goldman beat by 28%.
What you can discern from the current quarterly results information, and how you invest based on it, is worth considering in a later post.
Disclosure: I currently do not hold any positions in any securities mentioned. As with any investment, please do your own due diligence and only invest in any security based upon your own research and ability to withstand the risk to reward ratio. Investing in any security carries risk and market conditions can change rapidly.
Teaser Paragraph:

"There are lies, damned lies and statistics." Mark Twain

We’re in the middle of a US quarterly reporting season once again. For many, the company releases are just noise – the headlines make sense but the rest of the information doesn’t mean a great deal.

For others, the season provides a decent insight into corporate America, providing a good basis (or not) to invest in the market. To get the most out of the season, it makes a lot of sense to understand some of the dynamics within the quarterly releases. Here are a few tips on what to look out for.


 

 

 

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