per contribuire al gusto del dibattito posto alcuni argomenti di cosidetti perma bulls che però possono contribuire ad una visione dei mercati meno pessimistica di quella attualmente in corso sebbene ho già espresso da anni le mie riserve sui mercati finanziari occidentali di lungo periodo e sul fatto che ancora debbono subire ulteriori fenomeni deflattivi.
Allo stato attuale però le considerazioni sono troppo negative e le vie di uscita per i mercati finanziari esistono ancora, sebbene siano difficoltose.
In particolate il commento che posto evidenzia come due delle pricipali risorse di liquidità del sistema finanziario attuale, la creazione veloce di moneta da parte delle banche e la crescita del deficit commerciale USA sembrano in riduzione.
In particolare la prima è letteralmente scomparse con le conseguenze che conosciamo mentre la seconda sembra mostrare dei segni di recupero che avrebbe impatti considerevoli sui mercati.
Il commento si focalizza in particolare sullo strano fenomeno di questi anni in cui le riserve in dollari dei principali paesi esportatori sono spesso cresciute più rapidamente di quanto era il surplus commerciale dello stesso.
Questo è successo molto probabilmente perchè in molti di questi paesi molte persone hanno rpeferito indebitarsi in dollaro aspettandosi una sua debolezza (ad esempio in Cina).
Quando però questo meccanismo ha incominciato a trasmettere inflazione nei paesi interessati il meccanismo si è rotto o si sta rompendo basta vedere gli eventi recenti di India o Vietnam.
Questo potrebbe portare a breve ad un turnaround dei trend in atto ed ai dei cambiamenti significativi sui mercati finanziari.
Il trend del bund di questi giorni potrebbe essere un segnale di questi cambiamenti ad esempio.
I have done a couple of meetings and dinners with clients here in HK over the past couple of weeks and this is what I am being told:
- We have an improvement in the US current account deficit = bad for global liquidity (less money being pushed abroad), bad for emerging markets (typically)
- Bank shares keep on making new lows despite “plan B’ and despite Fed intervention. Banks are now -20% lower than where they were after BSC intervention. Three months after LTCM intervention, banks were 20% higher… so no end in sight to bank problems. Staying with bank problems, as a % of GDP the current crisis is bigger than S&L which took the better part of five years to really work through…
- Velocity is heading lower once again
- Our own recession indicators show negative growth
- Oil is obviously foremost on people’s mind. With oil above US$100, US recession seems hard to avoid. With oil above US$100, some Asian countries hurt badly. Finally, with oil above US$100, you get higher inflation and higher volatility in the cycle, and from there you get lower PEs…
- On this note of inflation, it is interesting to note that inflation is by far a bigger driver of asset class returns than growth. High inflation periods are terrible for investors while low growth periods can still be OK for investors…
- Lots of questions on whether the inflation genie can go back in the bottle without serious tightening, which would kill the fragile banks… Charles used to say three years ago that there was a race as to whom would go bankrupt first: Venezuela or GM. If oil rose, it would be GM, if it did not, it would be Venezuela… Maybe the question now is what the central banks do? If the central banks tighten aggressively to kill inflation, Citi/UBS/RBS (take your pick)… go under. If the central banks do not tighten and allow inflation to continue accelerating, India goes under?
- The complete lack of visibility on the policy front does not help matters. A year ago, it felt as if the adults were in charge. Now, it feels as if people are making it up as they go along. From china’s price controls, to India’s rupee devaluation, to Trichet’s amazing comments, to Paulson coming out every two weeks since August to say that the worst is behind us… a few clients noted that the political uncertainty has certainly helped shaved a few points off PEs.
- With inflation on everyone’s mind, clients do like the idea of hiding out in markets which do not have to fear inflation, namely Japan, Taiwan, US, Korea and Switzerland. Incidentally, these are the markets that almost everyone has been underweight for the past few years. Now moving to “overweight” the US will be tough for most people given that the US already represents 50% of the benchmark (World MSCI)… but overweighting Japan (around 10%) is a much easier step to take. Especially when Europe and Asia are underperforming and valuations in Japan are so cheap. We should expect big capital flows into Japan over the next 12 months as people move from underweight back to overweight (incidentally, data from Japan is not as bad as most people who fear Japan’s cyclicality believed).
So, by and large, the pushback is pretty bleak. Clients are worried and depressed; as one might expect given the fact that, like us, a lot of people started the year on the wrong foot and took some losses. They did not fully participate in April rebound and we are now once again testing, and sometimes much below (China, Phils, India…) the March lows… at least in Asian markets.
Anyway, for what it’s worth, here are my thoughts:
I think the most important question today has to be where this inflation comes from and how long it will last? Staying with Friedman’s definition of “inflation is always and everywhere a monetary phenomenon”, or even Rueff’s that “inflation is subsidizing expenditures that give no return with money that does not exist” (i.e.: money creation to finance budget deficits), then I think we should maybe look at the world this way:
Over the past few years, there have been TWO massive sources for global liquidity: 1) the US current account deficit and 2) the willingness of banks to leverage up their balance sheets willy-nilly
It is obvious that the later one is over. Banks have now written off 396 billion in equity. And although they have raised 302 bn in the aftermath of these writedowns, dilution has been enormous, lots of CEOs have been fired (and you know the new ones will come in wanting to be a lot more prudent than their predecessors) and the banks will not only have to face a world where they have to take less leverage but also where they face more stringent regulations (in all likelihood). Thus the days of fast money creation from the banks are over.
These two factors help explain some of the odd things that we have witnessed in recent years, such as the impressive growth in central bank reserves and the consequent weakness in the US$:
Indeed, one of the mysteries we have had to deal with is how could US$ central bank reserves pretty much all over the world grow SO MUCH FASTER than capital inflows into the various respective countries. In other words, how could a country like China SAVE EVERY YEAR US$30-US$100bn MORE THAN THEY EARN?
(See Chart 1)
This rise in reserves is all the more surprising given the spike in oil prices. After all, with oil prices rising by US$60 in 12 months, with the world consuming 85mbpd, with the world keeping around 100 days of inventories at all times (on ships, etc…), the rise in the price of oil should gives the world an increased price tab of US$500bn. How does the world finance that excess price tab? Typically, through the US current account deficit. After all, the only way to get dollars HISTORICALLY has been to sell stuff to Americans to get these dollars. But in the past couple of years we have seen the previously unforeseen event of RISING OIL PRICES + RISING CENTRAL BANK RESERVES. AND OVER THE PAST YEAR, WE HAVE SEEN THIS AT A TIME WHEN THE US CURRENT ACCOUNT DEFICIT WAS IMPROVING. That just seems nuts since the old equation would have looked something like Change in US current account deficit – change in oil price = change central bank reserves. So that equation obviously no longer works. Or we are missing a variable. The two variables I can think of are:
a) changes in assets owned by foreigners in the US
b) changes in US$ borrowing outside of the US
Then the equation looks like this: Change in US current account deficit + changes in assets owned by foreigners in the US +changes in US$ borrowing outside of the US – change in oil price = change central bank reserves.
And of course, two, or maybe three, of these variables namely US current acct deficit, willingness to borrow US$ and foreign holdings of US assets are closely inter-related. When the US trade balance deteriorates, foreigners are less keen for US assets + even keener to borrow US$.
Anyway, back to how we got into our current inflation problem, and how the current surge in inflation could be linked to the US current account deficit
1) We start off in 2001 with a perception that the US$ can only go down since a) US$ is expensive, b) US has massive trade deficits, c) US rates are very low and thus fail to attract foreign investors, d) political rhetoric in the US is not very foreigner friendly (see Bushwacking the dollar), e) the countries with the big surpluses (OPEC, Russia, China…) see the US as a foe, not a friend (unlike Japan, Germany, UK, France…) so are not likely/able to recycle their excess dollars there easily
2) So the US$ goes down
3) With the US$ going down, perception grows that borrowing in US$ becomes a “free call”. i.e.: I buy my apartment in Beijing with US$ loan since US$ can only fall vis a vis the RMB (see chart above for the macro effects of many people doing just that)
4) The people who borrow these US$ bring them to the central bank for local currency (in my case, the PBoC). The local central bank then has a choice: allow its currency to rise or print money aggressively. More often than not, emerging countries choose to print money (Brazil is a nice exception as they let the Real revalue – and incidentally, it is the one emerging market which is not busting right now under fears of inflation).
5) With fast money growth, we get fast economic growth and asset bubbles. We also get upward pressure on commodity prices, local real estate (HK, Singapore, Thailand…)
6) But with fast money growth, we also start to see faster inflation in Asia…
7) Meanwhile, the excess reserve growth in Asia, Russia and the Middle East increasingly gets recycled into European bonds, which allows excess EMU government spending (France, Italy…) and a strong Euro to live side by side… In turn, these capital inflows also help explain the very strong growth of European broad money aggregates
But this circle of manipulation is now broken. One of the reasons it is broken is that, in some of the countries, we start to see trade deficit deterioration (Vietnam? India? South Africa?...) and all of a sudden, the currencies weaken. But this goes against the plan that only the US$ can weaken… Meanwhile, the US current account deficit is improving rapidly and if/when oil prices turn around, we will likely see the biggest surge in US trade numbers that we have ever seen (right now, the improvements in US exports and reduction in imports is masked by the higher oil).
AND THIS IS WHERE WE ARE NOW: THE TWO SOURCES OF EXCESS LIQUIDITY GROWTH IN THE WORLD, NAMELY THE US CURRENT ACCOUNT DEFICIT (and the consequent belief that borrowing US$ is a one way bet) AND THE ABILITY OF BANKS TO LEVERAGE WILLY-NILLIE ARE DISAPPEARING.
Of course, the market believes that this does not matter since the Fed is out there printing money willy nillie. But as Charles made clear in this paper attached, this is simplynot the case.
And this should have a big impact on portfolios.
If we see “yesterday’s world” as being one of falling US$, fast money growth in Asia, low real rates, excessive lending then indeed the right bet was to be long commodities, commodity producers, Asian real estate, currencies other than the US$, reserve diversification into the Euro… can we be sure that we will remain in this world?
But if we start to transition towards a “new world” where a) the two sources of excess liquidity have dried up and b) central banks are not willing to step in and print money massively (which on recent rhetoric from Trichet, King, Bernanke and Zhou seems to be the case…), then the world is a very different place. Interestingly, the US$ is now falling against fewer and fewer currencies. Last year, it was falling against everyone. Now, it is falling against the RMB and the Real and either rising (against Won, JPY, CA$, GBP...) or staying steady (Euro, CHF…).
A turnaround in the US$ in the last six months of the year could have a massive impact on some of our markets. If it leads to a pull-back in commodities, equity markets would gain some air. Within Asia, manufacturers such as Johnson electric which have just been slaughtered would do the best. China and HK stocks could really rally hard as the turanound in US$ would mean a rapid abatement of inflationary pressures (which are currently weighing so heavily on the market). Australia would likely do very badly. India, which is already selling some of its reserves to prevent the rupee from falling too much against the US$ could also be hurt. Or they’d just let their currency slip…
Anyway, the bottom line is that we are at an inflection point. Either inflation continues to accelerate, but if it does you have to wonder WHERE the money comes from to fuel higher inflation. Or we start to face a US$ shortage.
Either way, not great news for financials?
