PIMCO Bill Gross the Ring of Fire

In his new year's investment outlook, the chief of PIMCO talks about public debt, consumer debt deleveraging, and prospects for emerging/advanced economies after financial crisis.

On public debt, he points out that Mckinsey study finds:

1. The true legacy of banking crises is greater public indebtedness, far beyond the direct headline costs of bailout packages. On average a country’s outstanding debt nearly doubles within three years following the crisis.
   
2. The aftermath of banking crises is associated with an average increase of seven percentage points in the unemployment rate, which remains elevated for five years.
   
3. Once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%.

A different study by Mckinsey also notes that:

1. Typically deleveraging begins two years after the beginning of the crisis (2008 in this case) and lasts for six to seven years.
   
2. In about 50% of the cases the deleveraging results in a prolonged period of belt-tightening exerting a significant drag on GDP growth. In the remainder, deleveraging results in a base case of outright corporate and sovereign defaults or accelerating inflation, all of which are anathema to an investor.
   
3. Initial conditions are important. Currently the gross level of public and private debt is shown in Chart 2.

So with IMF's projection of public debt as shown in Chart 3, his advice to investors:


1, for equities, go where the growth is, where the public debt is low, and where savings and trade surplus will help transform the economy into a consumer-driven economy, namely, China, India, Brazil...
2, hand the safe money to Canada and Germany, definitely avoid UK...

Enjoy reading the full article here:  PIMCO investment outlook

Politics dictates market

Three days of continuous heavy selling and spike in VIX set the stage for some further fall next week?  If January is any indication of what's ahead for the year, I am tightening the seat belt for a bumpy year.

Doubts over the economic and political front seem to suggest that there will not be short of company by short-term bumps. There is no way to tell whether the past week's selling may be the beginning of a larger correction or not, i'll focus on issues that may have a longer-term impact on the market, several to watch next week:

Bernanke's re-confirmation as Fed chief.   Removal of either (Fed chief Bernanke and Treasury Secretary Tim Geithner) sends bad signal to the market.

Budget deficit. Healthcare plan as part of it. Obama endorsed deficit task force. Up for Congressional approval. This is a long term problem needing long term solution. Any other solutions than higher taxes and less spending? inflate the debt off?

Fed meeting. Given employment number staying above 10%, do not have false hopes that it's going to raise rate soon. All the talks about "recovery" are smokes...

Obama State of the Union address. Upon one-year anniversary of his presidency the economy becomes Obama's economy, as people began to forget George W. Bush. The difficult part has just begun.

New banking regulation. Main street or wall street? Obama seemed to have made the choice. The former Fed chair Volcker made a comeback. He'll play the dragon slayer. The banks will fight viciously.

2010 Week 3 market

Equity market pulled back sharply this week, with DJI, S&P down over 4% (biggest weekly drop since Mar 09), in Asia HSI and STI down 3%.  Crude and Gold slipped 5% and 3% respectively.

Currencies Euro is the biggest loser against JPY losing about 6%.  USD also slipped against JPY by over 2% and ended the week at 89.85.

Upbeat corporate earnings reports yielded to negative news one after another - first is doubt over Greek government's ability to rein in debt issues, then China's Dec CPI release fueling tightening concerns, followed by uncertainty over several large banks' fate upon Obama administration's proposal to regulate and restrict banking activities.  The proposal is not a turning-back to Glass-Steagall which forced separation of commercial banks and investment banks after 1930 crisis, rather, it proposes to separate gambling activities (using bank's own capital) from investment banking's service business so proprietary trading, PE fund, Hedge Fund housed under the banks will go.  The revenue impact on the large banks varies but is estimated to below 10%. The proposal is up for Congressional approval and signifies another big challenges for the Obama administration after his Healthcare Plan.

A pull-back has been long-due given the uncertainties surrounding the economy as discussed before. How much further adjustment is hard to predict.  Standing on the sidelines and watching the development is the best thing to do. Of course, don't miss the chance to pick up some cheap stocks if the sell-off continues. My bet is it's driven by profit-taking and I'll position for a rebound shortly.

Break the banks up! or not?

The Obama administration is now ready to whip the banks' asses:

President Obama Calls for New Restrictions on Size and Scope of Financial Institutions to Rein in Excesses and Protect Taxpayers

The proposal would:
1.   Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.
2.   Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector.  The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

http://www.whitehouse.gov/the-press-office/president-obama-calls-new-restrictions-size-and-scope-financial-institutions-rein-e

Ever since the financial market was created, market makers (investment banks) were positioned to arbitrage the information asymmetry and to game the system.  It was the the academics who placed the aurora on the head of the surreptitious dealer whose actual well-being depended on the size of the gamble other people took.  Well, how the investment banks came to this "To-Big-To-Fail" is a long story.  This is a good book to read.

The point i want to make - Asian banks are as big as what they can get, what's making them not "Too-Big-To-Fail" down the road?  Singapore banks house investment banking activity and deposit-taking/lending business under one roof.  No doubt regulatory supervision is tighter here than US, is it the solution to excessive risk-seeking and conflict of interest?  (Well neither DBS nor UOB are seen as risk-seeking banks at present, however let's not mix incompetence with good risk management.  Assume one day Shenton Way become as competitive as Wall Street).  I always have doubt when the banks talking into your face about "one-stop service" and "better customer solution" - just look at Citigroup. One-stop shop helps the bank more than the customer.  The world will be a better place when hedge funds are hedge funds, investment banks are investment banks, commercial banks are commercial banks, research houses are research houses... Fortunately, for Chinese banks, the regulators separated investment banking business from commercial banks.  When regulations aren't working - it won't work as much as you wanted in a world where laissez faire capitalism is at heart, break the banks up.  Why not re-enact the Glass-Steagall Act?

Fear of sovereign risk

Big sell-off in EUR in the past a few days as sovereign debt issues dominated news headlines. At focus were Greece's ability to rein in its fiscal problems, Iceland president's veto on repaying UK and Netheland government the bailout fund for depositors who lost on the now-defunct Icesave bank, and lower German Economic Sentiment measured by ZEW survey.

ZEW is a collection of survey results with hundred of financial experts and is referred to as indication of economic sentiment.

http://www.zew.de/en/

ECB kept rate at 1% as expected on 14 Jan decision and warned the recovery of Euro zone would be bumpy. EUR has come down by 3% since then. It fell to 5-month low against USD yesterday morning to 1.407.

The fear of sovereign default is ongoing development. Financial crisis normally accompanies fiscal crisis/currency crisis/sovereign default as the days of extravagant spending of the welfare states is over and the payback time nears. It's a social and political struggle to face the bitterness of reality. Now Greece's 5-yr CDS trades at over 300bps, higher than Philippines and Indonesia. It adds further cost to Greece government and makes raising new debt more difficult.

Other news that's driving the market include China's increase of deposit reserve and fear of asset bubbles. China GDP grew at 8.7% in 2009, amid banking lending at 9.6 trillion yuan, which is a 96% increase over 2008. Central government has spoken a few times on reining in credit growth in 2010 and targeted new lending limit of 7.5 trillion yuan this year, a 24% drop. Yesterday friend in China told me that banks have frozen (yes literally no work for credit officers) new loan approvals until Feb.

Equity market and emerging market/commodity currencies also pulled back a bit in the past a few days.

US 10-yr bond yield dropped to 3.65% from 3.8% of last week.

Google drama

Google China office staff is back to work. Looks it was just a young man's outburst of dissatisfaction. It's inexperienced and may be a bit naive in trying to push Chinese government back. Too much testosterone. But that's why techies love it.

Unfortunately this incident will leave it with some scars. Just hope that it can skillfully walk out of this crisis with minimum damage. After all, it has already won the popular hearts of its supporters in China and around the world.

Bravo, Google!

Singapore December export number

Non-oil up 26%, amongst which electronics up 25%, pharma up 76%, petrochemcals up 64%
Oil up 60%

Export to major trade destinations China up 20% Europe up 27% US up 6%.

This is consistent with China's December export/import number.  Indication of inventory replenishment yet encouraging data. We may see consistent improvement for next a few more months. Faster inventory re-building also indicates potential production slowdown in several more months once re-building is completed as sales need to catch up.

US business inventory and sales data:

Industrial production

 Other data for reference: housing start

car sales

2010 Week 2 market

This is an eventful week.  Major market indices started the week down from Fri of Week 1, moved up in the middle of the week and fell back to where it started at close of the week.

Monday was the start of the earnings report season.  Alcoa's below-expectation Q4 result jittered the market. Tech stock was in spotlight in expectation of the Intel result. By Friday, another notable earnings report by JP Morgan and its revenue number didn't help lift the market. During the week, there is Google's high-profile announcement to potentially exit China - that's an interesting piece in that Google made headline again even when admitting its failure and frustration over its business in China! I am inclined to believe that this is a carefully deliberated strategy of exiting China.  At present its China business is insignificant - making less than 1% of its top line and given the painful progress it's making with the time and investment spent on China, i think the US managers have probably eventually came to conclusion that it's not worth throwing more money in any more for the moment.  Well, ebay, Yahoo had the same fate in China... but Google is Google.  "Do no Evil" - it wants the moral high ground and it reinforces its brand.  So the hackers' attack was a good excuse. Has Google ever feared hacker attack? how many attacks are happening every day around the world? After all Baidu - China's dominant search engine, was blacked out for 2 hrs just a few days ago and it hasn't warranted Baidu to point fingers at other people. Anyway, criticism and threat are not the way to resolve problems and it's Google's loss (I don't mean Google overall may lose in business sense. Instead the incident may help its international revenue in near term).  See you in five more years Google.cn!

During the middle of the week discussion on banker's pay and bonus tax re-ignited. Obama was adamant to make back 90 bln out of the 120 bln it lost on TARP funds (the number puzzled me though.  why not just 120bln?).  The tussle will go on.  The root of the problem i think is executive pay and corporate governance. In the past decade US executives paid themselves rich and in contrast companies, big or small, failed. The model clearly failed. I will be eager to see whether the managers are ready to accept changes.

Buried in the earnings numbers are the unemployment claims and retail data which are both slightly worse than expected. EUR and AUD pulled back against dollar and Yen strengthened by end of the week with pull-back of risk appetite.  Oil fell back to 79 dollars a barrel on both stronger USD and inventory data. Overall, it's another week of mood-swinging back.  I think we will go through a few rounds of back and forth by mid of this year with hope of strong recovery lifted and then receded again.  Yet my basic scenario has not changed.  I am keeping long commodities as inflation hedge as Fed will keep interest rate low at extended period and liquidity will remain plentiful so time of pull-back is opportunity to buy.

Surprises brewing?

What would be the major risks for the market in the new year? Will there be surprises that can bring the market down again to the levels of Mar 09 that is brewing? I would like to know. Unfortunately as someone said "Surprises won't be surprises if you and me know".

Still i am happy to make some wild guesses so i can observe it along the way -

1) Making to the top of the list is Sovereign Risks - watch out some European countries like Greece. Bad budget, high unemployment coupled with slow recovery can do damage to their debt rating. Downgrades of country ratings will drive away risk capital. There are more than one country on the watch list - Greece, Ireland, Spain, UK... Ukraine and East European countries are vulnerable. (should count Dubai in as well).

2) Fed stops printing money. The $1.25 tril asset-purchase program is due in march and non-extension of it will be signal to withdrawing liquidity. And depending on market interpretation (too soon) it may rattle the market. (may not be likely given the unemployment numbers)

3) Emerging markets face run-off inflation. As a consequence of keep printing money (as opposed to 2), high commodity price and other input price starts to feed into prices hikes of everything... It's likely to happen and no doubt there is concern over inflated asset prices. Some adjustments is due to come when central banks in Asia start to withdraw liquidity.

4) Run-off commodity prices... Are we going to see oil prices go above $100 again? maybe.

5) Commercial Real Estates write-down. Some estimates it's in the range of trillions (amount lost on Residential Mortgage comes to around $2 tril i think).

6) US unemployment numbers up again or stayed high for too long.

7) China export numbers down again

8) Major terrorist attacks, war in Iran, North Korea issue

2010 Week 1 market

Making up for last Sunday's writing.

Week 1 of 2010 ended on positive notes... Bulls in charge for the week globally. Global equity indices ended higher by Friday. Oil price broke $83 and Gold traded in the range of 1110 and 1120 as USD index maintained its strength.

No major downside surprises during the week but at weekend news of potential JAL bankruptcy filing came out (on Monday the news did some damage to Japanese market however was contained).

US bond yield continue to drift higher... 10-yr yield moved up to 3.85% by Friday and i think it's at 10-month high. News of faster-than-expected US recovery and inflation concern seem to have dominated the market for the week.

Most notable equity sector performance is energy related stocks. Conocophilips, China Oilfield services, EZRA, Rotary engineering all appreciated in the range of 10 to 25%.

On China announcement of measures to curb property speculation (mainly to 2nd home buyers by increasing installment to no less than 40%) did not make big impact on equity market. Eyes were on new year's monetary policy and government signaled tightening by increasing 3-mo bill yield. (More news broke out on Tues of the Week 2 that PBOC's increased deposit reserve by 0.5%). - It's evident that China is shifting policy gradually amid rapid price increases (not just housing, food, gasoline... too)

(Major news coming out of China on Sunday was December export number up 17.7% which is a big positive surprise. will see next a few months)

So the momentum has continued (in fact too buoyant) and i have no major change in view of the market direction.

A "W" shape recovery?

From Creditwritedown.com:

Double dip recession and the perverse math of GDP reporting

http://www.creditwritedowns.com/2009/12/double-dip-recession-and-the-perverse-math-of-gdp-reporting.html

The effect of stimulus and credit expansion has been felt strongly, in the financial assets and commodity prices. However we're all aware of many other indicators showing weakness in real economy... I think the question is whether the pace of recovery will be fast enough to take over the waning government stimulus by late 2010 to 2011.