China, beyond the hard/soft landing debate


Author Cam Hui

Posted: 11 July 2012

Imagine a country where a sector has dominated that nation’s economy and is deemed to be “systemically important” to growth. Insiders of that sector have made obscene profits from the growth. One day, we wake up and find that that sector has gotten in over the heads. The “logical” free-market solution is the let that sector go down and allow the economy to re-balance, but sector insiders have a cozy relationship with the government. If leading companies in that sector goes down, the collapse will surely take many in government down with them. What country am I referring to? What sector? What is the most likely course of action for the government?

One obvious answer to the first two questions is the finance sector in the West (see my last post Another test of the banking lobby’s powers). It’s a good guess, but I am referring to State Owned Enterprises (SOEs) in China.

The roots of China’s growth
The China miracle was fueled mainly by two factors:

  1. Access to a cheap source of labor and the willingness to use it as a source of competitive advantage to grow the economy; and
  2. The CNYUSD currency peg.

While the currency peg allowed Chinese labor to be highly competitive, it also created all sorts of nasty side effects. First and foremost, China was stuck with America’s monetary policy, which was inappropriate for China. As the Chinese economy heated up and inflation rose, Chinese interest rates could not rise with inflation and inflationary expectations because of the currency peg. Thus, real interest rates went negative.

Negative real interest rates created winners and losers. The winners were the companies with easy access to capital, which were mostly the SOEs at the expense of private businesses, which are often referred to as Small and Medium Enterprises (SMEs). An academic paper called A Model of China’s State Capitalism (h/t Michael Pettis) that shows that the dominance of SOEs and their superior growth is largely attributable to their monopolistic or semi-monopolistic positions in the Chinese economy, e.g. telecom, oil refining. etc. John Hempton called this arrangement a kleptocracy because Party insiders have become enormously wealthy at the expense of the ordinary citizen.

Negative interest rates also meant very low or negative cost of capital. As Japanese companies found out in the late 1980’s, it’s easy to make money when your cost of capital is that low. You borrow as much as you can and invest in something, anything with a positive real return. If you are positioned properly, you can make obscene profits – and they did.

Currency peg = Financial repression
The biggest loser in China, on a relative basis, was the household sector. The ordinary Chinese who worked hard and managed to squirrel away savings had few places to put their money other than the banking system. The Chinese bond market is not sufficiently large. The stock market is very small and undeveloped compared to major industrialized countries and is regarded mostly as a casino. The household sector was forced to put money into the banking system at negative interest rates. Carmen Reinhart calls that financial repression. Here is the definition from Wikipedia:

Reinhart and Sbrancia characterise financial repression as consisting of the following key elements:

1.Explicit or indirect capping of, or control over, interest rates, such as on government debt and deposit rates (e.g., Regulation Q).
2.Government ownership or control of domestic banks and financial institutions with simultaneous placing of barriers before other institutions seeking to enter the market.
3.Creation or maintenance of a captive domestic market for government debt, achieved by requiring domestic banks to hold government debt via reserve requirements, or by prohibiting or disincentivising alternative options that institutions might otherwise prefer.
4.Government restrictions on the transfer of assets abroad through the imposition of capital controls.

John Hempton at Bronte Capital outlined the dilemma of the Chinese household well:

The Chinese lower income and middle class people have extremely limited savings options. There are capital controls and they cannot take their money out of the country. So they can’t invest in any foreign assets.

Their local share market is unbelievably corrupt. I have looked at many Chinese stocks listed in Shanghai and corruption levels are similar to Chinese stocks listed in New York. Expect fraud.

What Chinese are left with is bank deposits, life insurance accounts and (maybe) apartments.

For those ordinary Chinese citizens who could afford it, the only logical place for savings is in real estate. Real estate became a form of money and savings poured into it. In effect, the CNYUSD peg was indirectly responsible for China’s property boom.

Where we are today
Fast forward to today. China’s growth has hit a slow patch. One of the objectives in the Party’s latest five-year plan calls for a re-balancing of growth away from heavy infrastructure spending, which has benefited SOEs, to the consumer (read: household sector). Andy Xie described the slowdown and how the authorities have managed to contain the worst effects of the downturn:

There are no widespread bankruptcies. The main reason for this is government-owned banks not foreclosing on delinquent businesses. Of course, banks may have more bad assets down the road, which is the cost for achieving a soft landing.

SOEs, the vehicle of wealthy Party insiders, have been hit hard:

State-owned enterprises (SOEs) reported 4.6% net profit margin on sales and 7.4% return on net asset in 2011. Both are very low by international standards. In the first five months of 2012, SOEs reported a 10.4% decline in profits but 11.3% increase in sales.
SOE performance indicators are low and declining. This is despite the fact that SOEs have such favorable access to financing and monopolistic market positions.

Xie also echoed Hempton’s kleptocracy claims, though in a less dramatic fashion:

Closer observation gives clues as to why SOEs are so inefficient. Their fixed investment often costs 20% to 30% more than that for private companies and take about 50% longer to complete. The leakage through overpriced procurement and outsourcing and underpriced sales is enormous. SOE leakage can explain much of the anomalies in China.

In addition to the problems presented by slowing growth, the financial system is teetering because of an over-expansion of the shadow banking system (see my previous comment Ominous signs from China). Left unchecked, it could have the potential for a crash landing, i.e. negative GDP growth, which is not in anybody’s spreadsheet model.

What will the government do?
In the face of the cracks exposed by a slowing economy, what should the Chinese authorities do?

The textbook answer is that growth has been overly unbalanced towards large infrastructure projects and tilt growth toward the household and consumer sector. The Chinese consumer needs to rise. The latest five-year plan specifies this objective in a clear fashion.

The problem with that solution is that it gores the SOE and Party insiders’ ox. For the household sector to rise, household income needs to rise. Wages need to rise. Returns to household savings need to rise. For this to happen, financial repression needs to end.

Ending financial repression would mean that real interest rates would need to rise, which would squeeze the cost of capital of Chinese enterprises – SOEs in particular. Would the Party cadres go along with that? This may be a case of where the leadership dictates a course of action but the bureacracy doesn’t go along.

The good news: A soft landing
Under the circumstances, the most likely course of action is a “more of the same” stimulus program. Already, we have seen a surprise rate cut, which does nothing for the returns of the household sector. We are likely to see more infrastructure stimulus. Already, we have seeing signs of a growth revival and signs of real estate revival.

The good news is that such a policy course will mean a soft landing in China. The bad news is that it will mean more unbalanced growth and it just kicks the can down the road. The next time the economy turns down, it will be that much harder to revive.

Bad news: End of the commodity supercycle
What’s more, such a growth path would mean the end of the commodity supercycle. The principal argument for being long-term bullish on commodities (which I have made before here) is rising household income in emerging market economies like China’s mean rising resource intensity. Greater household income mean that consumers want more stuff, e.g. cars, TVs, etc. This is shown by this analysis from the Council on Foreign Relations.

If financial repression continues and the household sector continues to get repressed, then where is consumer demand coming from? Moreover, there are indications (via FT Alphaville) that resource intensity may not rise despite greater infrastructure spending:

Nomura analysts Matthew Cross and Ivan Lee looked at China’s urbanisation rate and concluded that it can keep progressing at its current pace for years without needing an increased rate of steel consumption. In fact, they argue that China’s annual steel needs won’t increase at all in 2012 and 2013 — and that’s with new government stimulus.

Also see this chart (via FT Alphaville):

This is where I depart from commodity bulls like Jeremy Grantham. Even long-time commodity bull Jim Rogers has become more cautious on China.

More importantly, while the world focuses on the China hard vs. soft landing debate, I am thinking about the longer path for Chinese growth. They will slow down. When the next downturn hits, we could see a classic negative GDP growth recession.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.



None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Don’t lose sight of the medium term


Author Cam Hui

Posted: 18 June 2012

Rather than focus on Greece this weekend, I thought that I would write about the medium term path for equities and the global economy. I came upon this BIS paper entitled Characterising the financial cycle: don’t lose sight of the medium term! The BIS researchers break economic cycles into two components, a shorter business cycle and a longer financial cycle. Here is the abstract:

We characterise empirically the financial cycle using two approaches: analysis of turning points and frequency-based filters. We identify the financial cycle with the medium-term component in the joint fluctuations of credit and property prices; equity prices do not fit this picture well. We show that financial cycle peaks are very closely associated with financial crises and that the length and amplitude of the financial cycle have increased markedly since the mid-1980s. We argue that this reflects, in particular, financial liberalisation and changes in monetary policy frameworks. So defined, the financial cycle is much longer than the traditional business cycle. Business cycle recessions are much deeper when they coincide with the contraction phase of the financial cycle. We also draw attention to the “unfinished recession” phenomenon: policy responses that fail to take into account the length of the financial cycle may help contain recessions in the short run but at the expense of larger recessions down the road.

The financial cycle is turning down. Ray Dalio of Bridgewater explained the financial cycle using the Monopoly® game as an analogy in this note.

If you understand the game of Monopoly®, you can pretty well understand credit and economic cycles. Early in the game of Monopoly®, people have a lot of cash and few hotels, and it pays to convert cash into hotels. Those who have more hotels make more money. Seeing this, people tend to convert as much cash as possible into property in order to profit from making other players give them cash. So as the game progresses, more hotels are acquired, which creates more need for cash (to pay the bills of landing on someone else’s property with lots of hotels on it) at the same time as many folks have run down their cash to buy hotels. When they are caught needing cash, they are forced to sell their hotels at discounted prices. So early in the game, “property is king” and later in the game, “cash is king.” Those who are best at playing the game understand how to hold the right mix of property and cash, as this right mix changes.

Now imagine Monopoly® with financial leverage and you understand what is happening with the financial cycle:

Now, let’s imagine how this Monopoly® game would work if we changed the role of the bank so that it could make loans and take deposits. Players would then be able to borrow money to buy hotels and, rather than holding their cash idly, they would deposit it at the bank to earn interest, which would provide the bank with more money to lend. Let’s also imagine that players in this game could buy and sell properties from each other giving each other credit (i.e., promises to give money and at a later date). If Monopoly® were played this way, it would provide an almost perfect model for the way our economy operates. There would be more spending on hotels (that would be financed with promises to deliver money at a later date). The amount owed would quickly grow to multiples of the amount of money in existence, hotel prices would be higher, and the cash shortage for the debtors who hold hotels would become greater down the road. So, the cycles would become more pronounced. The bank and those who saved by depositing their money in it would also get into trouble when the inability to come up with needed cash.

What happened with Lehman in 2008 and in Greece, Spain and the other eurozone peripheral countries today are symptoms of the downturn in the financial cycle.

The business cycle turns down
There is no doubt that the financial cycle has been turning down since 2008. What about the business cycle? It’s turning down as well. Regular readers know that I use commodity prices as the “canaries in the coalmine” of global growth and inflationary expectations. Consider this chart of the negative divergence between US equities and commodities prices.

The market is also telling a similar story of an economic slowdown. Here is the relative performance of the Morgan Stanley Cyclicals Index against the market. It’s in a relative downtrend, indicating cyclical weakness.

Globally, air cargo traffic represents an important real-time indicator of the strength of the global economy (h/t Macronomics). This chart from Nomura shows the correlation of air cargo growth with global industrial production growth. Air cargo growth is headed south as well.

I have written about the Axis of Growth, namely the US, Europe and China and at least two of the three are slowing. Hale Stewart at The Bonddad Blog went around the world and explained why the global economy is slowing:

[T]here are no areas of the world economy that are demonstrating a pure growth environment; everybody is dealing with a fairly serious negative environment. Let’s break the world down into geographic blocks:

1.) China is located at the center of Asian economic activity. Recently, they lowered their lending rate largely as result of weakening internal numbers. While these numbers still appear strong to a western observer (growth just over 8%), remember that China is trying to help over a billion people become middle class. To accomplish that goal, the economy needs to have a strong growth rate. Also consider that the news out of India has become darker over the last few months as well. A recent set of articles in the Economist highlighted the issues: a political system that is more or less unable to lead, thereby preventing the action on structural roadblocks to growth. The fact that two of the Asian tigers are slowing is rippling into other regions of the world, which leads to point number 2.

2.) The countries that supply the raw materials to these regions are now slowing. Australia recently lowered its interest rate by 25 BP in response to the slowing in Asia. A contributing factor to Brazil’s slowdown is the decrease in exports to China. Other Asian economies that have a trade relationship with China are all experiencing a degree of slowdown, but not recession. Some of these countries (such as Brazil) were also experiencing strong price increases. The price increases are are starting to slow, but they are still above comfort levels.

3.) Russia has dropped off the news map of late. However, it emerged from the recession in far worse shape; it’s annual growth rate for the duration of the recovery has been between 3.8% and 5%, which is a full 3% below its growth rate preceding the recession. This slower rate of growth makes Russia a far less impressive member of the BRIC list.

4.) The entire European continent is caught up in the debt story — underneath which we’re seeing some terrible economic numbers emerge. PMIs are now in recession territory, unemployment is increasing and interest rates for less than credit-worthy borrowers are rising. And, the overall credit situation is casting a pall over the continent, freezing expansion plans.

5.) The US economy has experienced 2-3 months of declining numbers. While we’re not in recession territory yet, we are clearly in a slowdown with growth probably hovering around the 0% mark.

In addition, I have documented warning signs of rising tail risk in China (see Focus on China, Not Europe, Ominous signs from China and The ultimate contrarian sell signal for China?)In last week’s analysis, John Hussman said that the US is in recession now and blamed it on the financial cycle:

By our analysis, the U.S. economy is presently entering a recession. Not next year; not later this year; but now. We expect this to become increasingly evident in the coming months, but through a constant process of denial in which every deterioration is dismissed as transitory, and every positive outlier is celebrated as a resumption of growth. To a large extent, this downturn is a “boomerang” from the credit crisis we experienced several years ago.

Regardless of the outcome of the Greek election, my inner investor tells me that the fundamentals of the economic outlook is negative. When the financial cycle and the business cycle both turning down in unison, that’s bad news.

As for how much of the negative news has been discounted by the markets, I don’t know. What can change the trajectory of the outlook in the next few months is intervention, either by the central banks (which was rumored late last week), an announcement of more QE by the FOMC, or the news of some deal cooked up by the European governments, IMF, etc.

My inner trader tells me that fundamentals don’t matter and the markets will react to short term headline news.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

We Are Likely Close to a Capitulation Bottom


Author Larry Berman

Posted: 5 June 2012 re-posted from etfcm

Gold is breaking out, financials are breaking down, energy stocks are cheap and getting cheaper, and they are selling the utilities, which likely means we are close to a capitulation bottom.

The TSX did not make a lower low last week while most stock markets globally did. This bodes well for the commodity stocks and golds in particular making at least a short-term bottom. But if we are correct and the world is slowing significantly, not just because of Europe, but because of China’s harder landing scenario, then commodities do not bounce very high unless we see a massive coordinated central bank QE effort (which cannot be ruled out).

So traders, expect markets to be tough and focus on the daily and weekly charts for reversal signals. Right now, the weeklies are oversold enough and trying to at least make a short-term bottom with the better seasonals in June and July to support the bounce. The fall could be nasty once again especially with the US political theatre likely to be major fodder for the late night circuit. How can it be funnier than Palin-McCain you ask…it’s so sad it has to be funny.

 

Energy Sector Goes From Manic to Panic and Back Again


Author Larry Berman

Posted: 2 May 2012 re-posted from etfcm

The TSX touched the 200 and 50-day averages yesterday on the back of another strong surge in the energy sector, while the banks remained soft. We often see banks begin to adjust a few weeks before earnings, and this time is no different. The energy sector went from manic to panic and now to maniac again in “hopes” that nat gas has made a major low. While likely very close, we see another test below $2 before a major bottom is likely to be confirmed.

For every 1% the TSX can bounce, take 5-10% of equity exposure off the table. We are quite confident that we have a date with 11,500 before we see 13,000, but following that plan, you would be nearly fully out of the TSX if by some miracle, the TSX moves higher.

Do not bet on crude oil going to $115 any time soon, but there is a big position between Brent and WTI to unwind, and forced spread trades can move markets for longer and farther than anyone can speculate. Outright shorts and hedges using HIX should be considered if the TSX reverses to the downside above 12,500.

 

Not enough panic to buy yet


Author Cam Hui

Posted: 23 Apr 2012

Now that we are nearly at support on the Spanish IBEX 35 Index, my inner trader tells me it’s too early to be buying. We need to wait for more pain and panic to materialize. My inner investor says that signs of value are starting to show up in a number of natural resource sectors and it’s time to start accumulating positions in resource cyclicals.

Spain a contrarian buy, but not yet
Soon after I wrote my last post (see Why I am buying the pain in Spain), Macro Man and I seemed to be on the same page when he wrote that Spain is unlikely to crash:

To TMM [ed. TMM=Team Macro Man] it would appear that the only scenario that supports selling right now is one where Spain crashes, doesn’t receive assistance, defaults and the euro and then Europe break up. Now call us picky but though that indeed is one potential outcome there are a lot of other scenarios and most of them involve some internal resolve, even if it does involve printing your amount of money. Elections may change the leaders of some countries but as the UK Con/Lib coalition is finding out, they are but the tip of the iceberg of the machine that is government. There is enough mass below the waterline that knows where its true interests lie to stymie any threats to them. Yes Minister indeed.

In fact, they were piling into the Spanish trade:

Having piled back into equities last week the current mood should be considered as red flags to us and we really ought to run with the pack, chop the longs, swing short and whip up the doom. Instead though TMM have decided to do the reverse and have broken the glass on the cabinet containing their Kevlar Gloves and bought some Spanish stocks of international appearance ( braced for comments). Hold on tight !!

Recall that my original premise for buying Spain is to wait for a period of maximum pain and panic (see How much more pain in Spain?). The defining moment was the 2009 lows, which would be a level of technical support for Spain’s IBEX 35 Index.

Now that we are nearly there, I don’t think we’ve seen sufficient pain and panic in the markets for Spanish equities to be a contrarian buy yet. My inner trader thinks that TMM should be following his initial instincts to “run with the pack, chop the longs, swing short and whip up the doom.”

Consider this chart of European stocks, which exhibited a break of an uptrend, but the index is not showing any signs of panic yet.

What about the euro? The EURUSD exchange rate is holding in nicely, thank you very much.

So are 10-year Treasury yields. No signs of panic there either.

Is the market about to hit an air pocket?
I am starting to see the signs of a change in leadership. While my Asset Inflation-Deflation Trend Model remains in at a weak neutral reading and I am not in the business of anticipating model reading changes, my best wild-eyed guess for the stock market is a gut-wrenching correction, followed by an explosive rally as the Bernanke Put and Draghi Put kicks in.

Consider the relative return charts below. The top chart shows the relative return of the Morgan Stanley Cyclical Index compared to the market. Cyclicals are underperforming and they have been in a relative downtrend after topping out in early February. By contrast, defensive sectors such as Consumer Staples and Utilities have been bottoming out relative to the market this year and recently started to outperform.

These are the signs of a change in leadership pointing to a deeper correction in stocks.

Value in resource sector
Despite the negative near-term prospect for cyclicals, I am seeing signs of value showing up in the deep cyclical sector, particular in the resource sector. Canada’s Globe and Mail featured an article detailing that while energy companies were going like gangbusters:

Alberta’s oil patch is roaring. Oil prices are flying, pipelines are pumping millions of barrels a day, and companies are engaged in a rollicking spending spree.

Every 2½ weeks, companies shovel another billion dollars into oil sands projects. Drilling rigs across the province are tapping big new pools of oil. And firms desperate for skilled workers are scouring the globe to help them get on with ambitious growth plans. Western Canadian oil output is expected to surge by more than a third to 3.6 million barrels a day by 2018.

Their stockholders were missing out on the party:

Alberta’s energy frenzy has all the makings of a hollering rodeo party. But there’s one group conspicuously missing out on the action: investors.

In the midst of a boot-stomping boom, oil and gas has been among the country’s worst-performing sectors of the stock market. Since the global economic crisis, benchmark oil prices have soared from below $40 (U.S.) a barrel to above $100. Many Canadian energy stocks, however, have been left in the dust.

Indeed, this chart of the XOI, or Amex Oil Index, against the price of WTI shows that energy stocks are historically cheap against oil. Arguably, the graph doesn’t show the true picture as XOI is shown against WTI, which has been trading at a discount to Brent, which is becoming the de facto benchmark for the world price of oil.

We see a similar picture with gold mining stocks. The Amex Gold Bugs Index, or HUI, is trading at a huge relative discount to gold bullion and the relative relationship is approaching the post-Lehman Crisis panic liquidation and capitulation lows.

The slope of the recent price action of the energy stock/oil and gold stock/gold ratio, however, tell the story of controlled selling rather than the panic selling that characterize a capitulation low. That’s the same picture that I see in the IBEX 35, the Euro STOXX 50, Treasury bond yields and the EURUSD exchange rate.

A market crash is unlikely
Longer term, however, I expect that asset prices to be well-supported by the Bernanke Put and Draghi Put. Consider the Italian MIB Index as a bellwether of market fortunes. While there is downside risk, tail risk is likely to be mitigated by the Draghi Put and the near-by presence of major technical support that stretch back to the mid 1990’s.

As the table below shows, this week is a big week for Spanish equity market, as most of the Spanish banks are expected to report earnings. Bad news could provide a catalyst for another downleg, which would be a set up for the good contrarian to start buying.

In summary, my inner trader tells me that there isn’t enough panic here for him to step up to buy, but my inner investor, who has a longer time horizon, tells me that it’s time to start nibbling away at long positions in distressed sectors, such as Spain and resource stocks, at current levels.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.



None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Hope for TSX Rests in Mining, Oil & Gas in Coming Months


Author Larry Berman

Posted: 2 Apr 2012 re-posted from etfcm

The fact that Canada added 80K+ jobs matters little to the TSX. The TSX works based on what is happening other places in the world and a weak US NFP report is far more important to the TSX than Canada’s “job gains.” If the much anticipated correction for the S&P 500 is about to unfold in the coming months, then the TSX does not stand much of a chance unless oil & gas and mining stocks start to lead. We think gold stocks stand a very good change of bouncing back in the coming months, but the banks, insurance companies, and the energy stocks, significantly less.

That said, the energy stocks are now relatively cheap compared to the TSX and very cheap compared to the banks, so probably a little rotation will be seen in the coming weeks and months into some of the higher energy dividend payers. If we are correct and the European banks are due for another summer of discontent, our banks will likely suffer some collateral damage.

 

Bernanke is Clear on Triggers for QE3, and We Aren’t Close to Them


Author Larry Berman

Posted: 31 Mar 2012 reposted from etfcm

The next top that is likely to develop over the coming months will likely serve to suck in any remaining sideline cash while the smart money continues to distribute shares to the late to the party lemmings.

Of course, we are only correct here if the real economy is not improving and we are only getting the benefit from Bernanke stimulus. If the economy is really improving, which we doubt, then earnings are just fine and valuations remain relatively cheap. Is that the case or not? We think not, but we’ve been wrong before.

We are at a key point of inflection, so we have reduced client exposure to half the maximum for our US large cap and small cap portfolios. At this point, we see the glass as half full, so we are half in. If the glass breaks, leaks, or fractures, we’ll turn exposure to zero. Otherwise, we are waiting for higher levels to feed the quacking ducks on TV as to how wonderful the recovery is.

The Senate had the opportunity to pass important legislation to take unneeded subsidies from big oil (XOM made $50B+ EBIT) and channel them into renewable and other productive technologies—they failed!!!


The energy bull still lives


Author Cam Hui

Posted: 06 Mar 2012

Ambrose Evans-Pritchard recently wrote an article entitled Plateau Oil meets 125 Chinese cars, in which he discusses why oil prices haven’t fallen despite the anemic nature of global economic growth [emphasis added]:

What is deeply troubling is that Brent crude should have reached fresh records in sterling (£79) and euros (€94) – with a knock-on effect on US petrol prices, mostly tracking Brent – even though the International Monetary Fund has sharply downgraded its world growth forecast to 3.25pc this year from 4pc in September, and even though International Energy Agency (IEA) has cut its oil use forecast for this year by 750,000 barrels per day (bpd).

Oil is not supposed to ratchet defiantly upwards in a downturn, which is what we have with the Euro zone facing a year of contraction in 2012, and much of the Latin bloc sliding into full depression. Japan‘s economy shrank in the fourth quarter.

The reason is Peak Oil, or Plateau Oil, where crude supply is not expanding to meet rising global demand because of rising emerging market affluence.

Asia’s emerging powers of Asia – the key force driving the commodity boom of the last decade – are in various stages of “soft-landings” after hitting the monetary brakes last year to check property bubbles and curb inflation. China’s manufacturing has been bouncing along near contraction levels through the winter. So what happens when it recovers?

The unpleasant fact we must all face is that the relentless supply crunch – call it `Peak Oil’ if you want, or `Plateau Oil’ – was briefly disguised during the Great Recession and is already back with a vengeance before the West has fully recovered.

The commodity markets are now selling off over China’s new GDP growth of 7.5% as it shifts from export driven growth to internal consumption growth. I would argue that the move is commodity bullish (instead of bearish as interpreted by the market knee-jerk reaction) because resource intensity grows because of the shift to consumption, as shown by this analysis from the Council on Foreign Relations.

Indeed, the emerging market demand story has become so prominent that Big Picture Agriculture points out that Asian oil demand has already risen to exceed North American demand.

Not too late to buy energy stocks
It’s such these kinds of positive fundamentals that makes me a long-term commodity and energy bull – and it’s not too late to buy energy stocks. The chart below shows the price chart of Select SPDR Energy ETF, or XLE, going back to 2000.

I have also constructed a crude trading signal for energy stocks. Below the main XLE price chart, I show the relative performance of the more volatile Oil Services ETF (OIH) against the more stable XLE, which is more heavily weighted with integrated oils. Note that troughs in the OIH/XLE ratio have been good times to buy. Investors would have seen higher prices within a year after each of those buy signals. Moreover, if you had waited for the OIH/XLE ratio to rise by 0.25 to 0.30 after each of those buy signals and sold your position, you would have profited handsomely.

We just saw a buy signal for energy stocks last year. Based on the OIH/XLE ratio, it’s not too late to buy and ride the energy stock bull.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

War with Iran:Would you go bankrupt for your country?


Author Cam Hui

Posted: 26 Feb 2012

There has been a fair amount of chatter about a geopolitical risk premium on the price of oil stemming from a conflict with Iran. While I generally don’t agree with candidate Ron Paul on most matters, I do agree with him when he said in a debate last week that America can’t afford another war.

The Institute for Economics and Peace (h/t Josh Brown) came out with a paper called Economic Consequences of War on the U.S. Economy, which Josh summarizes as:

  • Public debt and levels of taxation increased during most conflicts;
  • Consumption as a percent of GDP decreased during most conflicts;
  • Investment as a percent of GDP decreased during most conflicts;
  • Inflation increased during or as a direct consequence of these conflicts.

Fiscal conservatives should be appalled by the march to war, especially when you consider the immense deficits that are facing the government today. I once rhetorically asked if the Pentagon has a downward sloping demand curve and today I very much doubt it. Consider this account of how gasoline costs $400 per gallon in Afghanistan – that’s before the Pakistanis cut off supply routes that raised prices roughly sixfold. Are American interests in Afghanistan that important to warrant those kinds of costs? (I read somewhere once that the United States spent $1 million for every Vietnamese man, woman and child during the Vietnam War. Could it have achieved its objectives for a lower cost?)

Instead of fighting wars intelligently, the military industrial complex focuses on the development of gadgets like the iRobot’s Warrior, which is “strong enough to tow a car and dexterous enough to open its trunk using the handle.” Is this the sort of device the military really needs in a counterinsurgency?
Imagine if your local police force deployed such machines instead of real people and you interacted with them through an automated call center. How would that affect your interaction with the police? Would you trust them more? Or less?
Instead of fighting wars intelligently, the military industrial complex is now intent on building the Death Star – and damn the cost!
Star manager Jeff Grundlach compared the US to the Roman Empire. American share of global military spending is 43%, but meanwhile its debt is spiraling out of control.

During times of vital interest to a nation, its leaders have asked its young men to be prepared to die for their country. On the other hand, how many Americans are prepared to lose their jobs and homes and go bankrupt for their country?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

 

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