Greek tragedy

The investment community is still mired in the economic and risk discussion which follows from the traumatic experience in 2007 – 2008. Debt crises and confidence crises are back. Greece CDS spreads are widening to all time highs as there is the overall chatter that the default is nigh and investors should be wary of risk and Euro. Obviously CDS trading and pricing can very arbitrary especially in respect to Greek bonds. Furthermore investors forget that no country can be forced politically or legally to leave the Euro or the EU. It would come close to suicide it Greece should decide to leave Euro. A crisis of unpredictable consequences would ensue and it is difficult to see that any government would prefer such a solution to the slow arduous pain when the country stays in the Euro zone.

Greece is only 3% of EU GDP. Does the impact from the current CDS and bond debacle seems strangely disproportionate. Clearly there is worry about Spain, Italy and Portugal which could have similar difficulties in the future. Those three countries would have a much larger impact on the EU and the Euro.

Investor would need to evaluate a question or rather a set of questions which would guide the future investment decision. On the one hand there is a country which appears to be debasing its currency and issuing a mountain of debt. The debt worry is not contained to certain states but rather to a whole country. It currency is the world reserve currency on a brink of losing the competitive game as it is progressively replaced by other currencies or gold.

On the other hand there is a common area which tries to control inflation and budget deficit in order to create a stable economic environment. Even if sometime few member believe that budgetary imbalances are not as important as the economic growth. Admittedly there are few areas which suffer form the debt problems. Those problems can be easily solved but may inflict substantial pain on the citizens and the economic performance initially.

A decision which market and currency offer a more sound long term fundamentals is relatively easy to decide.

Despite the Greek worries Euro appears not to suffer unduly. Could it mean that the end of the current weakness may soon appear?

Tech is back

Could you have imagined telling it to an investor that tech is back and it will become the leading sector for the quarters or maybe even years to come? Well, not really. There are many lost decades in the financial history. Obviously Japan is the most widely quoted although it is easy to argue that it is not only one decade but rather two. Now as this comparison is famous and widely used it is easy to see that the bubble formerly known as TMT has been widely forgotten and had its own lost decade. The TMT fell apart into tech, telecoms and media. Each had and has its own problems to fight thus continuing to disappoint investors although 2009 showed that tech can still surprise and deliver a performance which is better then the main equity markets. People mostly abandoned the sectors and focused their minds on emerging markets, commodities and new energy solutions.

Contrarian investor should be looking for areas that are mostly abandoned by the common investor and the areas which are deemed to be mired in insurmountable difficulties which will preclude the sector or market from delivering good returns over the coming periods.

One of the out-of-favour areas is apparently the tech sector. There is apparently little hype at the moment and the tech seems to be of little relevance for the global economy. Or, is the area significant?

Some of the old technology is being brushed aside by the slew of new consumer products. Touch screens and iPods, Windows 7, new mobile telephones, netbooks, navigation and Google. This list is obviously only a small selection of recent developments.  The electric car and photovoltaic are the other two important drivers of new technology development. It is not a pioneers land any longer. Tech is main stream with new grown up applications and hardware ready to conquer the consumer world.

At the same time there is a major new consumer world developing to embrace all the new technology. China, India and the other Emerging Markets are growing a new breed of a young tech dedicated consumer who is willing and ready to embrace new upcoming technologies.

The internet goes not only global but also mobile. The old borders between mobile and fixed line become blurred. All offerings are content rich with video and sophisticated graphics eating up the capacity and requiring ever more computing power.

It is no longer a one way road. The downloads and uploads are equally important as people do not only consume the internet, they continue and intensify to contribute and populate. The viral nature becomes now ever more present.

The chip production capacity is increasingly taken up by the new environmental push driven by new car concepts and alternative energy, photovoltaic. An average hybrid car requires some one square meter of chips to run efficiently. This is some three times as much as conventional cars. Future cars are expected to use even more chips and computing power.

Finally tech companies are no longer cash burning, over capacity burdened hyped companies. They are increasingly efficiently run with high cash flow and low gearing. They deliver returns on their capital which are one of the best in the world. This could surprise all the veterans of TMT but companies do learn their lessons although it can take years. The competition is less on price but rather on products and services. Price will be continuously an important determinant of the competitive position but the whole sector become more rational.

Watch this space. In the future internet will be on the mobile devices in your pocket, your car and your bike. The early dream that most people will be able to be internet connected all the day to stay in touch, work, communicate, shop, make tax returns, and so many more things is becoming reality. Web 3 where the user does not only connect to the web for services but increasingly to activate and operate devices at home and at work, produce energy and intelligently distribute it. All this could drive the next tech revival unexpected by the unwary investor.

Happiness and Growth

This time I feature an interesting commentary from a friend of mine with an sharp and controversial mind.

Enjoy the different view of the world as you experienced already in the commentaries before.

It was in the 1980s that the king of Bhutan, Jigme Singye Wangchuk declared that :

“Gross National Happiness is more important than Gross National Product.”

He was of course referring to his country at the time but the concept has universally gained ground over the last two years.

Gross National Happiness comprises of four pillars that embody national and local values, aesthetics, and spiritual traditions.

1. equitable and equal socio-economic development,

2. preservation and promotion of cultural and spiritual heritage,

3. conservation of environment and

4. good governance which are interwoven, complementary, and consistent.

The dogma of growth at all costs is over.  Economists led by the flagship, the Economist magazine, have traditionally argued that economic growth is the essential basis for the continued well-being of society and GDP is the statistic used to measure it.  From a political viewpoint, growth means employment. Even Angela Merkel has been talking of growth at all costs. On the other hand, President Sarkosy of France has established a Commission on the measurement of Economic Performance and Social Progress which has attempted to replace GDP with a broader measurement including the quality of ordinary lives.

The US declaration of independence

WE hold these Truths to be self-evident, that all Men are created equal, that they are endowed by their Creator with certain unalienable rights that among these are Life, Liberty, and the pursuit of Happiness.

I do not dispute the fact the economic growth is essential for businesses to grow and prosper. Then again periods of slow growth or recessions are also essential for the shake out of non-productive and inefficient industries and companies to allow for the rise of new technologies and innovations.

Unfortunately the recent history of present governments has been to prevent this natural process by subsidising ailing industries at all costs to prevent rising unemployment. The concept of short-term growth became a religion in it‘s own right.  So far, this still seems to be the case as governments do not seem to have any other solution to the present debt crisis than by providing more debt, or pouring more petrol on the fire with the hope of putting it out.

In all previous recessions over the last thirty years the mood of the people hit their lowest points in those periods. Why is it then that, despite the recession, the Happiness index in the US has increased this year?

According to Nancy Gibbs in a Time article, it is all about what she calls, the “expectation index.” During periods of economic growth, our expectations for the future outpace our growth of income, or spending power.  We expect our overall living standards to continually improve with better cars, new stereo systems, strawberries at Christmas, etc….

These expectations were magnified by the huge artificial wealth created by the arrival of the credit card, hire purchase and other means of cheap debt that the governments encouraged and supported to achieve the goal of short-term growth.

This inflation of expectations is a burden on our happiness just as much as the inflation of money is a burden on our wealth.

So now, as the reality of the severity of the crisis sinks in and people start to earn and save once more rather than borrow and spend, the inflation of expectations reduces and there is almost a relief that it is over.

China and US-Dollar

Over the recent weeks the strong political and economic situation in China did manifest itself in a rising confidence. Chinese officials are increasingly resistant to Western criticism on economic, political and moral grounds. The western influence in China is diminishing rapidly as the fast growing most populous country in the world displays its newly found strength.

This would mean that any calls for the revaluation of the Chinese currency will be met with disdain and refusal. The world cannot dictate the supposedly new leading super power how it has to run its economy. China perceives itself as the saviour of the world from the abyss of the economic disaster. A saviour is obviously without a fault. Thus any calls from US or the Western Europe for the currency revaluation would fall on deaf ears.

However, there could be a development of unintended consequences which may inevitably force the invisible economic hand. China was the global manufacturing hub for the last decade. It was supporting the unstoppable desire of the US consumer for manufactured goods. The consumer, as we know it now, was funded and supported by the debt spiral which caused one of the most vicious economic disasters of the last 100 years.

Now China needs to recalibrate its economy from export-orientated to consumer and domestically orientated. The manufacturing base exists to satisfy additional consumer demand and the consumer is not only supported by the growing consumer loan business in China but especially by the strong domestic economy fuelled by monstrous infrastructure projects which are providing new jobs and demand for locally manufactured goods.

The expectation is that the trade surplus will vanish over the coming quarters and a trade deficit will emerge. Thus export orientated economy may become slowly but steadily depended on imports putting more pressure on the call to revalue the currency. However it is likely that China will not give in to these calls.

On the other hand unexpectedly US-Dollar could become the mechanism which will discipline the Chinese currency independent of political decision. The Chinese currency is virtually pegged to the US-Dollar. Thus if and when US-Dollar strengthens the Yuan will strengthen accordingly. This would deliver the unintended consequences. The Chinese consumer would profit from cheaper imports. Domestic companies catering for the domestic consumer would become more competitive. Traditional exporters would have more incentives to focus on domestic demand. Chinese huge FX reserves and US debt pile would gain in value potentially supporting further economic strength. The goal of stronger Chinese currency could be reached without the Chinese government losing its face and actively deciding for the currency appreciation.

The consequences for US economy might be very different. However, at the moment it appears more that the world is turning into a kind of oligopoly with US and China its strongest players followed by India, Brazil and Russia in the second line. It would be an unexpected outcome if the greatest consumer of the last decades could turn into a manufacturing base for the former exporter with booming new consumption culture.

Spot the bubble

During a long journey often the companions play games which helps the time to pass faster till they reach the next destination or just a goal. The current new game on the journey in the financial markets appears to be: spot the next bubble.

There are plenty to choose from. But a few shall be mentioned here. Any reader who misses one which is not mentioned here is welcomed to add his or hers personal bubble to the list. The longer the list the nicer the game.

The bubble which is mostly discussed by global equity strategists appears to be the china equity bubble. There are obviously couple of permutations on the theme: China property bubble, Asian equity bubble, emerging markets equity bubble.

The clear derivative of these bubbles is the commodity bubble particularly driven by industrial metals and most visibly manifested by the gold price.

The supporters of the dark side of the financial markets who love to predict the gloom and doom would take those bubbles to a more logical and dark conclusion. Credit bubble is obviously not over. The consumer is deleveraging but now a more irrational player entered the stage. Governments, now taking place of the consumer and allow the credit bubble to continue. Cheap funding in form of low interest rates are pushing banks and other financial institutions into buying the seemingly safe government debt. This bubble could become the new mother of all bubbles.

This could lead to a more pronounced and dangerous kind of bubble which would have a major impact on the global economy. Inflation. Inflation could become unbearable to the world as the central banks are expanding monetary base and governments are increasing debt.

There is a lot of fame to be gained from identifying the next bubble correctly. All the media will definitely report on the fact after it occurs and the person who identifies it will be influential for some time. However as it became obvious over the last years it is a tedious business and nobody is able to consistently predict bubble and the timing of creation and bust. After the fact it is very easy indeed.

Pragmatic investor would need to observe that the bubbles offer the greatest investment opportunities in a given time period. The bubble runs longer and further than expected offering a tremendous profit opportunity. When the bubbles collapse they fall harder than anticipated again offering tremendous profit opportunity. It is clear that high risks are associated with high profits this is the basis of all economic development. Thus a rational investor should embrace and cherish a bubble. Ride it high to profit as long as only possible. The problem is obviously of the risk and timing. The longer the bubble last the more risk of a reversal to the overstretched trend. Investors would have made already tremendous profits. The logical course of action would be to lower the risks but keep the trade on. The major psychological problems is that as long as the profits are rising it is difficult to realise at least portion of the profits. Many investors feel very comfortable with rising profits and actually increase risk taking through leverage instead of de-risking.

The bubble will burst one day and investors need to be prepared to close the trade and embrace the opposite side of the same momentum. When bubble burst a great opportunity presents itself on the other side: the short side. Many may call it the dark side.

Thus investors can ride the bubble up and down like a giant roller coaster. Just never forget that the longer it runs and the more profits clicked in the more vicious will be the reversal. Keeping risk controls firm and well structured and allowing for ever tighter stops in order to exit the risky trade is paramount. Investors can enjoy the ride as long as it lasts but should never forget to abandon it in time and with discipline. Unfortunately the more investors approach the top of the bubble the more comfortable they feel and the risk is neglected. This leads to disasters. The more respect investor has from scaling new heights of a bubble market the better he is prepared to cope with the aftermath which can be as profitable as the bubble itself. Just keep your hands firmly on the controls and do not lose your head. RISK is the most important four letter word in the bubble surge and decline.

How not to reason

Following the disturbing revelations about possible decoupling between US-Dollar and equity markets numerous readers requested fundamental explanation for this outrageous idea. It is always profoundly difficult to argue which of the numerous moving parts will definitely have the impact on the possible decoupling. However, there are few indications and ideas why the correlation decoupling could happen.

Sentiment: most investors are convinced that US-Dollar will weaken further.

Economy: US economy may recover faster and stronger than European economy. There are numerous indications that unemployment rates may stabilise thus allowing for consumer revival. Oil prices are weaker allowing for short-term improved consumer power. Credit conditions seems to be improving. Weak US-Dollar could support exports.

China: is not particularly interested in weak US-Dollar due to large FX reserves.

Europe: peripheral disturbances from potential credit defaults in Greece or other countries of the Eurozone. This would obviously add to the Euro risk and investors may not be attracted by the low interest rates at the core of Europe, speak Germany.

Carry trade: there is a notion that the US-Dollar trade may lose some steam as Japanese Yen improves competitive terms.

Obviously, anyone could come with more interesting ideas. Interestingly the predictions made based on the fundamentals may point in the right direction but the triggers may be unexpected. This time it appears that the better unemployment numbers and dynamics were the trigger few days ago. Chose your favourites and observe the outcomes.

Of Markets and Dollars

It is always important to stand still on the cross roads especially if you travelled well in a good company. However sometimes it is time to part or stay with the company. Parting is never easy as investors like other people are easily getting used to comfortable travel companies which they know and trust. Parting with those companions can be very difficult and disturbing.

It was a great time to play the correlation trade between Emerging Market, weak US-Dollar, stronger equity markets and stronger commodities.  It appears that this correlation trade arrived at the cross roads and either it can be sustained or it will break down.

Strategists and investors are not prepared to embrace idea that stronger equity markets could be associated with stronger US-Dollar. Obviously following couple of quarters of rising and high positive correlations it is very hard to imagine that it could change.

The rule and not the exception is that correlations over time change and investors shall be prepared to live with it and to embrace those changes as great investment opportunities. Since the unemployment number have been published a week ago and continued to be confirmed by economic numbers following last week US-Dollar gain visibly strengthened. Initially, equity markets experience strong volatility but finally seem to have stabilised and are currently trying to decouple from the US-Dollar move.

By now even the biggest sceptics of the economic recovery who are mired in the discussion if global economic recovery is going to have a W, V, U, L or any other shape, must have discovered that global economy and even the US economy are recovering.

OECD leading indicators appear to be stronger than 1991 and 2001 and even 1983. Global and US steel production is peaking up and the so much cherished US rail car loading factor is up 12.4% indicating further strong economic activity. Even Federal Reserve just reported that the consumer net worth increased. Just to make all the doubters feel even more doubtful the November retail sales increased by 1.3% double what has been expected by the analysts.

Unexpectedly, at least for the majority of commentators, US economy found some disputed strength and recovers. Thus it appears only understandable that US-Dollar shall recover. Stock markets could follow as economic recovery gets embraced by the doubters. Although a lot of the good news is probably already discounted in the equity prices it is still possible that as the marginal buyer returns to the equity market the prices increase.

It is always important to be prepared and willed to entertain new ideas when you are faced with a wealth of uniform opinions. The majority of investors are right most of the time. The crowed is only wrong at the tipping points in the momentum trade. The momentum of the correlation trade might have just hit the tipping point.

Bumpy road

Financial markets are travelling now on a bumpy road. The equity permafrost bears are coming out from their hidings although the spring did not arrive yet. They believe that the equity markets are in a topping zone and that sooner or later in the next months or even weeks we will experience another lag of the secular bear market. Some even predict that we may be testing the 500 level on S&P 500.

Following the bumps and jitters on the road some of the fallows who decided to join me in my travel are asking questions when the road will get smoother and the markets less bumpy. Or, shall we all follow the bears and park our money in some safe haven?

The seasonality obviously is generally supportive. We should not expect equity market weakness in the next 6 weeks or so.

On the other hand the market volumes are low and the volatility indices are showing low reading prompting numerous commentators to conclude that investors are too complacent. The following chart shows that during the initial stages of the bull market in early 90’s and 2003 till 2006 the volatility was much lower. The equity markets are more like in the middle of a long term range

VIX volatility index

Source: Bloomberg

What spooks the markets are obviously the ghosts of the past: credit and default. Thus the Dubai saga develops, the rating agencies downgrade Greek sovereign bonds and put Spanish sovereigns on a  negative view. Additionally US-Dollar gains strength.

The sovereign bond downgrade frenzy is reaching new highs. Now the current environment is ripe for high frequency of speculations which range from which European countries could have long term financing problems to which countries will be forced to leave the Euro zone.

US-Dollar is seen as the leading indicator for market direction and most investors would not entertain the idea that stronger greenback could be associated with stronger equity markets.

Thus there are plenty of issues to worry about and the major market tops are generally associated with exuberance not worries.

Thus the chances for a market rally into end January still exist. However if the market decides that this year is different and begins to correct the best attitude is to follow the market and not try to be a hero and stand in its way.

Revisiting Dr. Doom

Obviously there are other well informed financial people who do not believe in Mr. Roubini’s doom and gloom scenario for the markets. Obviously it is easier to become famous with horrible predictions as the world is currently very susceptible to such theories. Please read the attached article which shows why Dr. Doom could be wrong in the short and mid-term.

http://www.bloomberg.com/apps/news?pid=20601039&sid=avARgMioihVQ

Emotional Golden Horizon

Gold appears to be as emotional an object of desire as it ever have been. Following latest blog there was a wealth of comments and feed backs. This can be obviously divided into two major groups: bulls and bears.

Those supporting the gold’s latest performance believe that the statements were too bearish and that the future potential of gold price appreciation was severely understated. Some even complained that they have not been invested enough and that they should have invested all the liquid assets in gold and not even touch other assets.

The bearish community cherished the view that the trend is overextended and it will be sooner or later that the gold rally will falter and the overexcited bulls will be wiped out.

This means that some clarifications are required though the issue will remain as emotional as ever and only finally the price development will prove the one or the other group right.

Judging by the length the bull market in 70’s the current bull market could still take 1 to 2 years to unfold. Strong gold markets are generally associated with volatile and weak equity markets often described as secular bear markets. The equity market is currently mired in the secular bear market mode for the last 10 years. Excessively high interest rate spreads, as shown in the former blog entry, could indicate developing inflation which could support further gold price appreciation. Finally in order to reach the same real level of gold prices the gold price would need to rally by some 80 to 90 percent in order to reach same levels as in early 1980’s.

Investors should not forget that we are not at the beginning of the bull market in gold but rather at the later stages. This means that the majority of gains have already been realised and the longer the current trend continues the more dangerous it becomes. Over extended bull conditions are very volatile and prone to swift and vicious reversals. Thus the risk increases at the moment.

The sentiment is clearly strongly in favour of the continued gold price appreciation. The sentiment is generally a contrarian indicator at the extremes. This means the trend may not be critically overextended but some caution is required. This can clearly be seen in the sudden volatility increase which developed on Friday following better than expected economic numbers and offer some cautious note. Bottom line is that it appears USA is not losing jobs at a break neck pace as expected by the investors. The job market could unexpectedly stabilise or improve economic conditions in the coming months.

Once the numbers have been published there was a very interesting development to be observed which escaped obviously most of the commentators. US-Dollar rallied sharply on the news and well correlated gold did lose strongly at the same time. But stocks rallied initially, weakened again and made some late comeback.

This gold volatility is not unexpected. It should and will develop closer to the price top. Thus enjoy the ride as long as it lasts but please do not forget to cash in once the gold price turns and crashes under the weight of the metal and sentiment. The obviously tricky question is when will it happen? Let us watch this place.