Monday, December 12, 2016

China vs USA trade not a level playing field

I think what Trump is interested is doing is level the playing field. He regards himself as the world's best negotiator, and I think what he's really doing is throwing the opening gambit out there on the chess board to see where we go from here. He's been rattling China's cage with the call with Taiwan. 

China has basically had tremendous growth on the last three decades largely on the back of US consumers. Now we got a lot of cheap goods from China but there has been far from a level playing field. 

I'm not saying we don't have some subsidies for our companies and so on, but China is notorious for subsidizing government owned companies and all kinds of actions.....

Monday, December 5, 2016

Donald Trump economic policies to create winners and losers in emerging markets

Donald Trump’s electoral triumph has stoked expectations for a fiscal stimulus that will propel U.S. economic growth and spread to the rest of the world. For emerging markets, though, his presidency ends a long party. For some of them, it's about time economic reality hit home. For others, the future looks a bit brighter.

Early in this economic recovery, investors leaped into emerging-market stocks and bonds as those economies and markets promised faster growth than in the developed world. There was plenty of money to do so as the Federal Reserve and other central banks flooded the world with liquidity.

In 2009 and 2010, those economies grew much faster than the U.S. As foreign direct investment surged, investors who'd bought into emerging-market stocks were rewarded with much higher returns than were available in the broader market:

That trend, which began to falter at the beginning of last year, is now being reversed. In the week ended Nov. 16, a record $6.6 billion flowed out of emerging-market debt, according to data from EPFT Global, halting 18 consecutive weeks of inflows. In the second full week of November, exchange-traded funds that buy emerging-market securities saw withdrawals around the world worth $1.4 billion. While the surging dollar would seem to help emerging markets by boosting their exports, that is more than offset by other negatives, such as rising interest rates that are sucking money out of those economies.

Trump’s America First protectionist plans may soon add to the pain. He has promised to abandon the tariff-cutting Trans Pacific Partnership trade agreement between the U.S. and most Asian nations. He may force changes in the North American Free Trade Agreement that will hurt America’s southern neighbor, Mexico. On the campaign trail, he branded China as a currency manipulator and talked of a 45 percent duty on Chinese imports. Even though he's toned down that rhetoric, investors are wary.

But not all emerging markets are equally vulnerable. Those that can weather a protectionist storm and higher interest rates are those with current-account surpluses, including the Philippines, South Korea, Malaysia, Taiwan, China and Poland. Their foreign-currency reserves provide the money to fund any outflows of hot money without provoking a collapse in their own currencies. China's reserves, for example, are down 22 percent from their mid-2014 peak.

The losers are those emerging markets without that crucial buffer -- Brazil, India, South Africa, Argentina, Egypt, Indonesia, Mexico and Turkey. They have current-account deficits, so are importing capital to fill the gaps and have to take stringent measures as foreign money flees. Their foreign-exchange reserves tend to be slim, about half the size of those of the first group in relation to gross domestic product.

In contrast to the healthier emerging market economies, the deficit countries have currencies that have been falling against the dollar for the past five or six years, spectacularly so in chaotic Argentina. Economic growth among the deficit economies has also been weak except for India, which may in time join the healthy group if Prime Minister Narendra Modi succeeds in curbing corruption, eliminating economy-distorting subsidies and reducing business-retarding regulations.

With inefficient economies, slow growth and more entrenched corruption, the deficit economies also have much higher inflation levels than the surplus economies. And, with inflation problems and pressure to support their currencies, all except India have seen central bank rate hikes in recent years, in contrast to rate declines in the healthier group.

All emerging-market leaders aim, of course, to spur economic growth and curtail foreign capital flight while controlling political and social unrest and avoiding the effects of increased global protectionism. The International Monetary Fund estimates that a surge in global protectionism could reduce global GDP by more than 1.5 percent over the next several years. That would make the job even harder and helps explain why emerging markets are out of favour. But investors would be wise to differentiate between those nations best able to weather the storm, and those whose participation in the good times was less justified.

Wednesday, November 30, 2016

World is moving away from Free trade and globalization

The stunning victory of Donald Trump over Hillary Clinton was the culmination of the voter angst in Europe and North America that I identified in my column on November 23, 2015. They are “mad as hell” because purchasing power for most people has been declining for more than a decade. So voters have rejected mainstream politicians and turned to the political fringes.

The root causes of weak incomes are financial deleveraging and globalization. In the 1980's and 1990's banks and other financial institutions worldwide borrowed heavily to finance economic-growth-propelling lending. Also, U.S. consumers ran up their debts and ran down their savings rate to finance rapid spending. But the financial crisis and pressure from regulators have forced banks to retrench, and U.S. households have switched from a borrowing-and-spending binge to a growth-retarding saving spree.

Globalization, the most significant economic phenomenon of the last three decades, has transferred manufacturing from the West to China and other developing countries, eliminating many well-paid jobs in North America and Europe.

The voting climate was ripe for demagogues who blame weak purchasing power not on its basic causes but on income polarization (in the case of Hillary) and immigration and imports (in the case of Trump).

Trump struck the chord of voter discontent. He won even though he continually got off point, had numerous detours into his history of womanizing and got into a nonstop catfight with Hillary over who was the bigger crook and moral degenerate.

What does Trump’s triumph mean for investors? After an initial drop, stocks rallied sharply, presumably in anticipation of tax cuts and massive growth-reviving fiscal stimuli.

But the euphoria is overdone. As Congress grinds through Trump’s proposals, many will likely be watered down. He ran as an outsider without the support–and, in many cases, to the disdain–of many key Republicans. Tax cuts, though not on the scale Trump proposes, are also likely, in the unjustifiable hope they’ll stimulate enough growth to finance themselves.

The Mexican peso nose-dived in line with Trump’s threats to build a wall on the Mexican border and get the Mexicans to pay for it. But the dollar is rising against most major currencies. This may be in expectation of a strengthening U.S. economy and higher interest rates but also reflects the greenback’s safe-haven status. A rising buck is probably the best, safest investment strategy at present.

The world has been moving away from free trade, but the election of Trump accelerates things. In times of domestic weakness, which is now the case, governments and central banks try to promote growth at their trading partners’ expense. The Bank of Japan, the European Central Bank and others are trying to trash their currencies to promote exports. And Obama’s tariff-cutting Trans Pacific Partnership was rejected by both candidates. Consequently, emerging-market stocks and bonds are vulnerable.

Voters are demanding economic growth and higher incomes, and both Trump and Clinton put forth plans for major fiscal stimuli. Infrastructure, much in need of upgrades, will benefit. So will the military, with the Republicans in control of Washington. Military spending is done directly by the federal government and can be increased fairly rapidly, but infrastructure outlays take several years to come to fruition. So investors may be jumping the gun there.

By calling for fiscal stimuli, the Fed and other central banks have admitted that monetary policy is impotent. They won’t allow the leaping deficits that finance the stimuli to push up interest rates and offset the positive effects. They’ll essentially buy those new sovereigns, the helicopter-money phenomenon. Also, there’s the threat that Trump and the Republican Congress will reduce the independence of the Fed and encourage central bank cooperation.

So the initial postelection jump in interest rates and the selloff of safe-haven Treasurys in anticipation of huge Treasury borrowing were probably a vast overreaction. It all may be retraced–and then some–as investors again face the stark reality of a deflationary world, with chronic price declines likely unless offset by rapid economic growth sired by massive fiscal action.


Monday, November 14, 2016

Interview with Guru Focus - Part 2 Final

What are your biggest concerns at the present time?

The political landscape, we have many unusual politicians who have received lots of attention. You have Justin Trudeau, the Prime Minister in Canada, Marine Le Pen of the Front National in France, Jeremy Corbyn, leader of the U.K. Labour party, there is the far left and right in Germany and France, and of course in the U.S. So we had virtually no growth in real inflated adjusted income for most people in Europe and North America for over 10 years. People are reacting and saying they have to blame somebody and the mainstream politician gets the complaints. In the 1976 movie "Network," there is a guy who yelled, "I’m mad as Hell and I’m not going to take it anymore". I think this is where a lot of voters are today in Europe and North America. I think the result is probably going to be a big push toward fiscal policy stimulus, as monetary policy is not working that well anymore. In the U.S. there are two areas where this might be detected, one is infrastructure, we certainly need a lot of work on roads and bridges, railroads, etc., and most Democrats and Republicans could agree on that. The other one is defense spending, and this would be more favorable if the Republicans controlled both the Senate and the White House. You also have Japan being much more militaristic, and of course Russia invaded Ukraine. We detect some frustration going on there, and we will see how it plays out. Could Marine Le Pen become president of France? It’s possible! And, of course, the U.S. will be very interesting, and I will look at our current election very closely. I think that even if a more mainstream politician gets elected in the U.S., it may well be that Congress and that new president may want to do something to stimulate the economy because the voters are not very happy.

Do you think new fiscal policy would be the right thing to do?

Certainly in the case of the U.S., we can use the infrastructure improvement. There is a lot of slack in the economy, the labor market still has a lot of it, industrial operating rates are still very low. So yes, there is plenty of room, and the only question is always whether or not the money will be efficiently spent. That is the problem with government programs: they are very well-intentioned but very often they are not efficient in terms of their spending; they do not have a bottom line.

How would you change that?

I think that I would favor investing in the infrastructures: construction companies, suppliers of raw materials, basic industries, and if the investment is big enough, it could revive the U.S. economy sooner than it otherwise would. If not, we are still working off the excess of our indebtedness built up in the 1980s and 1990s, and there is no indication that this deleveraging process is over, and it probably has to run for a couple more years. Infrastructure investment could revive the overall economy. Even if there is a will, nothing will happen before the new president and Congress get elected. By the time you get this all geared up, you are two or three years down the road, but with market anticipation, so you can detect this anticipation faster than the actual spending.

Do you think the worst for China has yet to come, or has it already passed?

China had benefited from this globalization, the movement of industrial production to an emerging economy. China has the biggest economy and the most obvious one, we talked about this earlier in the case of Australia. That globalization process is pretty well completed. If you look at U.S. manufacturing as a percentage of GDP, it was 50% of GDP in the late 1800s. About 20 years ago, it was 20% and now it is 12%. I think the great shift of manufacturing to China is over. We are at an irreducible minimum, so that sort of growth in China is over. The other thing that created growth in China came from massive infrastructure spending and they created a lot of ghost cities, excess in infrastructure and huge debt to finance it. So that process is pretty well over now. Now what China is faced with is shifting its economy from one driven by exports and infrastructure to a consumer economy and it requires some reorientation, a process that takes a lot of time. In China, this shift is still in its very early stages. From the standpoint of globalization’s effect on the rest of the world, it is pretty much over and the shock that people had over China when they saw the increase of commodity imports, well that is pretty well over too. It is pretty much like Japan. Everybody thought that Japan would take over the world in the 1980s and then they had a housing collapse, followed by a stock market collapse in the early 1990s, and then for the last 20 years, nothing. I think China is going to be the same, it is not going to go away, but as the major focus of attention on the global stage I think it’s pretty much over.

Economists point towards financial instruments as exacerbating the fragility of the finance sector. While often innovative, many financial products allow higher risk-taking, are likely to have unrealistic valuations and are difficult to regulate. Many call for better regulations. Do you think this is possible given the inter-connectivity and complexity of global financial markets?

There is no question that financial markets have been excessive. The only justification for finance is to grease the wheels of industry, to provide the financing. If you did not have finance, you would have had a borrower economy, which is very inefficient. But what has happened in recent years, and particularly with slow economic growth, is that finance really took over and it is an end in itself, and we have got tremendous financial excess, a lot of which got wiped out in the financial crisis. But not all of it, particularly in the U.S. The bailout of banks and others left a lot of it intact and I am not sure more regulation is the answer because if you increase the regulation of the banks, the money moves to the shadow banks, the hedge funds, private equity, and I am not sure that is a very healthy situation because then you do not really know what is happening out there, the degree of leverage, with very little regulations in those areas. However, that is probably going to continue because the responses of regulators in the U.S. to the big banks bailed out was to break them up in order to reduce their size to the point that they are not too big to fail. But the banks pushed back on that, so the regulators, in effect, said OK, you do not want to be broken up so we will regulate you to the point you would like to be broken up. And that is what they are doing, and they have relieved them from different profitable activities like proprietary trading, derivative origination and trading. And they were pushed back to lending, basically taking deposits and lending the money out with a spread with a very flat yield curve for long term rates in relation to short term rates, which is not a very profitable business so it has put the banks in trouble. This resulted in further regulations, further increased capital requirements on the banks. I do not think this changed it to a zero risk profile, but it certainly pushed the action elsewhere.

Would you recommend more regulation in the shadow banks?

It probably makes sense from a theoretical standpoint, but if you did that, it would probably be so disruptive and result in a tremendous reduction in finance entirely, to the detriment of the economy. I think there is probably a case to be made for trying to control this.

And finally, to which moments in history should we look if we want to move past these cycles of financial crises?

The biggest concern that I have now is that people are trying to jam the current economic and financial situation into some kind of a regular cyclical pattern. We experienced fairly regular cycles early in the post-World War II period that ran through the 1950s, '60s, '70s and even the '80s, but then when you started to see all the leveraging up that took place in the financial sector and U.S. consumer area and other sectors in the 1980s and the '90s. Then it was of course followed by the financial crisis, great recession, very slow growth. I think it created a very different environment.

So to me the problem is that people are looking for a simplistic kind of answer, they are looking for something like a cyclical pattern and where are we in that cycle, so as to know what to predict next. I do not think we are in anything like the typical post-World War II cycle. I think the greatest mistake that a lot of younger people make in particular, is that they are looking backward nostalgically to that era, assuming it must be the same cyclical pattern as the 1950s and 60s, enabling us to follow the script and see where we go from there. But I do not think that is the case. I think we are working off this massive leveraging, we still have this overblown financial sector, and we still have slow global growth. And we know strong growth covers a multitude of sins. Really, when you have strong growth you can make a lot of mistakes! But when you have slow growth, it does not take much to fall into a recession. You look at the emerging economies in Africa, for example, who earlier had strong commodity prices and a lot of money coming in, but they did not use that money to restructure and diversify their economy, resulting in these countries now being in terrible financial shape. I think this means we are in a different era, and I do not think it is anything comparable to what we saw earlier.

Wednesday, November 9, 2016

Gary Shilling Business Insider interview

BI: A while ago, you put a 1% forecast on the 10-year Treasury yield, and 2% on the 30-year. Are you still bullish on bonds [implying that bond prices will rise and their yields will fall]?

Gary Shilling: Yes I still am for three reasons. 

One is the safe-haven effect. We're in a pretty tumultuous world, and there's a lot of uncertainty. Treasurys are where people go as one of the few safe havens in the world.

The second thing is that despite the recent conviction of many that we're headed back to inflation, I think deflation remains the more likely prospect. You've just got too much excess capacity in the world.

The third reason is that Treasurys, as low as yields are, are higher than they are in most other developed countries. A foreign investor picks up a yield spread in Treasurys versus their own sovereigns, plus the fact that if the dollar is going to continue rallying — and I think it will because it's a safe haven — then they get a currency translation gain as well.

BI: But with the specter of a Federal Reserve rate hike coming, do you see any upward pressure on yields?

Shilling: Not really. If you look back historically at the post-WWII period on average, if you get a 100-basis-point increase in Fed funds, the spillover to the ten-year is only 35 basis points, and 25 basis points into the 30-year — it’s a fairly small spillover effect.

Another factor here is that I think that the Fed wants to raise rates because they’ve been yelling and screaming about it. They’ve been crying wolf for so long that their credibility is shot, and I think they feel they need to.

Investors aren’t willing to accept the idea that we’re in an era of lower returns. And the Fed worries about those distortions.

One of the things I think is very likely is that with the prospects of robust fiscal stimulus in response to voters mad as hell, the Fed is going to be in there with helicopter money. In other words, they’re going to be buying whatever the Treasury issues. They’re not going to, in effect, advocate strong fiscal stimulus and then not finance it. And that’s helicopter money.

BI: Oil prices have held in a $40 to $50 range for some time even though there's been no solid OPEC agreement and US inventories are still high. Why are prices still holding up, and is there a bigger correction coming?

Shilling: I think so.

There was a bounce a year ago that didn’t hold, then you got down to $26 per barrel on WTI in February, then you got up to about $50, now we’re back to $45.  I said earlier last year that I thought we’d get to 10 or 20 bucks because that’s the marginal cost, and when you’re in a price war, it’s the marginal cost that determines the price.

It is a price war because basically the OPEC reason did not cut production in their November 2014 meeting was that they got tired of cutting production and having American frackers and Russians etc grab market share. OPEC production went from 30 million barrels a day to 33 million. They flooded the market, and it’s lost them a lot of money. Look at the Saudis: they just floated a $17.5 billion debt offering, they earlier borrowed $10 billion from a group of international banks; they’re selling part of Aramco — they’re desperate for money.

What’s happened is that in their game of chickens, they are the chickens. The cuts they’re talking about are not meaningful — about 600,000 or 800,000 barrels a day, which is easily made up by frackers who are now coming back to life with increased productivity, and Russians as well.

So they are right back to where they were, except now they have lower credibility. They are the swing producer, and of course the serious question is whether they’re going to get agreement. They already exempted Libya, Nigeria, and Iran. I think it was just wishful thinking that they were going to do anything to agree to cut production meaningfully in any way.

Monday, November 7, 2016

Is it better to be feared or loved

A Trump win might be bad for stocks, but it would be very positive for the dollar and Treasurys.

Now, that sounds ridiculous on the surface, because here’s this loose cannon who’s unpredictable. But that’s the point. He is so unpredictable that foreigners are going to look around and say "boy, we’ve got to head for the safe havens." And one of the safe havens is Treasurys and [another is] the dollar.

We’ve seen that in the past that where you’ve had uncertainty, and even where the Fed is raising rates, Treasurys rise as everybody heads for safety.

Machiavelli said it’s better to be feared than to be loved. If someone loves you, they can fall out of love with you but they’re probably going to keep fearing you. That’s where we are with Trump.

It’s awfully hard to even speculate. What they say going in and what they end up doing are terribly different.

Let’s say Trump wins. Is Congress going to let him build a wall on the Mexican border? I don’t think so. Yes, we’re in a protectionist era because when you have lack of domestic growth, everybody tries to unload the problem on foreigners with protectionism, devaluations, cutbacks on imports. But is there going to be a dramatic change? TPP is dead anyway, and similar deals in the euro-zone are going nowhere.

And if Hillary is elected, is she going to be able to jack up taxes with virtually no deductions, and include capital gains? Unless democrats have a clean sweep of Congress, I don’t think that’s going to happen either.

The one thing I think is likely to happen under either candidate is massive fiscal stimulus. You have so many voters in Western Europe and North America who’ve had no real income growth for over 10 years, and they are, in the words of Howard Beale, "Mad as hell and not going to take it anymore." 

Monday, October 31, 2016

Gary Shilling interview with Gurufocus - Part 1

You started your firm in 1978, about 38 years ago. Looking back, what would you have done differently?

I would probably start earlier. I always had the desire to start my own firm, and by nature I am not cut out to work for other people as I am too independent. I think this is the reason I have had the success I have had, because I can say what I think. But what I found difficult is that in the financial service industry, most people are paid to be bullish. As you know, I was fired twice by Don Regan, who was the CEO of Merrill Lynch, for forecasting recessions. I was Merrill Lynch's first chief economist and in 1968 I had forecast the 1969-70 recession that occurred, but it was not being bullish on America, which was the Merrill Lynch slogan of the day. So Don Regan fired me, and I took my entire staff with me to another firm, which was later bought back by Merrill Lynch so I got fired again. The story on Wall Street is that I am the only guy who was fired twice by Don Regan. The reality is that most people on Wall Street are paid to be bullish and I am not the only one who was fired for having different views. Being right or wrong is not important so long as you are bullish. Most economists have lived through a number of bear markets and recessions but they have never forecast one, at least they never talked about it. Again, if I were to do it all over again, I repeat that I should have started earlier.

Previously, you told me about your successful bet on the Australian dollar, can you tell us a little more about that thesis?

The Australian dollar was simply a way to play the decline in growth in China. China basically grew because of globalization, which I think is the most significant world economic event of the last three decades, the shifting of production, mainly manufacturing, from developed countries to China. It did not change the overall demand for manufacturing goods, but it concentrated their production in China. Of course, the story is that Australia is the main big supplier of coal to China as well as iron ore and other minerals, so China is basically difficult to short, as they control their currency, they control their stock market. The only way you can really short China is through stocks in Hong Kong, which is not quite the same. So the Australian dollar was simply a way to short China, nothing against the Aussies. They are digging up the island continent and basically sending their minerals to China. That was pretty much the whole rationale there.

What are the fundamental things you pay attention to when looking for opportunities in currencies?

I think the reality in currencies is all about global economic growth. Countries are always looking for ways to increase their production, and if this does not happen domestically, then their approach is to increase exports, and the way to accomplish this is to make them cheaper through currencies. So there exists a global desire to devalue against the U.S. dollar, something we see in the commodity currencies: Canadian, Australian and New Zealand dollars. Other commodity currencies are the Brazilian real and Mexican peso. Then you have the euro currency and the Japanese yen, with those central banks are deliberately trying to trash their currencies. Again, because they want to increase exports. Then you have the so-called "me-too economies”: South Korea, Taiwan, other Asian currencies and elsewhere, who want to join the parade; that includes China. China really wants to devalue and have a weaker currency. This is difficult for China to accomplish, and it started a year ago. With the collapse in stocks in China, there was a tremendous outflow of money and they tried to accommodate that by loosening their foreign currency reserve, which was decreased from $4 trillion to $2.2 trillion, basically to accommodate people wanting to move their money out of China. They traded U.S. dollars for Yuan's. They would like to devalue their currency but they are afraid that if they do, it will create an even greater outflow of money. One of the things China has done is to link their currency to a basket of currencies, so they can say they are flowing with the other currencies and going along with the crowd. They are very opaque about this, and one is not quite sure what they are doing versus the U.S. dollar. I think in terms of currencies, the U.S. dollar is the best bet. Virtually everybody else is trying to make their currencies cheaper relative to it.

When we are looking into currencies, should we look at exports?

In a theoretical economic sense you look at exports but I do not think exports, per se, are that important. Many countries are simply trying to increase their exports, in term of the export import balance. It is a big determinant of currencies these days but I am not sure it is as important as delivered government policies. In the case of the commodity currencies, yes, I think it is true of the Brazilian real, Russian rouble, Canadian, Australian and New Zealand dollar. The weak commodity prices are very weak there. Regarding the yen and the euro, they are driven by central bank policies.

Any authors or books you could recommend for developing a better understanding of currencies and their markets?

None that I can think of at the moment, as currency markets are now divorced from the normal determinant. For example, one of the things that has periodically received a lot of attention is purchasing power parity, the idea that a Big Mac costs about the same in the U.K., France, Canada, China or wherever. The idea is that ideally the currency should adjust to bring the prices into balance, but unfortunately this is not the case because currencies are so politically driven that I do not have any book I would recommend.

Starting from the beginning with currencies, it is all about global economic growth, and as long as growth is slow and we are now in the age of deleveraging, working off the excess of the 1980s and 1990s we will have a great desire to devalue. Of course, to the extent that everybody devalues, they can offset each other.

via Gurufocus

Monday, October 24, 2016

Central Banks and QE results

Central banks are finally realizing that their attempts to spur economic growth with low interest rates, then QE and most recently, negative rates, haven’t worked.

In tacit admission of the impotency of money policy, central bankers are intensifying their calls for fiscal stimuli. 

via Thinkadvisor

Monday, October 17, 2016

irrational exuberance in REITS ?

Last month, the overseers of the S&P 500 index split real-estate companies from financial stocks, creating an 11th equity category in response to the growing size and outperformance of the sector in recent years. Investors, though, should ask themselves if this is the property market’s equivalent of shoe-shine boys giving stock tips. 

Against a background of record-low interest rates, $62 billion flowed into U.S. real-estate funds from 2001 through 2015, with more than 120 Real Estate Investment Trusts going public and raising more than $38 billion. There are now 240 REITs listed on the NYSE and Nasdaq exchanges, with the real estate sector accounting for 3 percent of the S&P 500’s market capitalization.

Yields on REITs have traditionally exceeded those of the broader S&P 500 index, and leaped as house prices collapsed in the housing crisis a decade ago. The spread between the two yields then was fairly constant for about four years, but in the past two years, the difference has widened in favor of REITs. Investors have warmed to REITs for their ability to generate hard cash here and now, rather than waiting for capital appreciation from the (expensive) wider stock market. The combination of healthy dividends and price recovery means total returns for REITS have surged after bottoming in 2009.

Earlier in the recovery, single-family housing was subdued as many potential new homeowners lacked the credit scores, down payment money and job security to buy. They were also chastened in the aftermath of the price collapse; home ownership plunged as those who did form new households moved into rental apartments instead.

That drove rental vacancy rates down and multi-family housing starts up. About two-thirds of multi-family units are rentals, and building has recovered to reach 420,000 per annum, surpassing the earlier annual norm of about 300,000 starts. But single-family housing starts -- even after rebounding to a 720,000 annual rate from a low of about 400,000 -- are still far below the pre-housing bubble average of more than 1 million.

Even as house prices have recovered, they’ve been outpaced by rising rents. As a share of median income, rents have jumped while mortgage costs have fallen. Consequently, the National Association of Realtors’ Housing Affordability Index, even though it’s down from its March 2012 peak, is still well above its January 2007 nadir.

This index assumes that a household with median income buys a median-priced house with a 30-year fixed-rate mortgage at the prevailing interest rate. So its ups and downs are driven by family incomes, house prices and interest rates.

I broke the index down into its component parts, comparing the January 2007 to March 2012 increase, the March 2012 to June 2016 decline, and the entire lifespan. The earlier rise was fueled equally by declining mortgage rates and falling house prices. The ensuing decline in affordability was due to the leap in house prices, with small offsets from declining mortgage rates and rising income.

Since the start of 2007, the primary driver of the net 46 percent rise in affordability is the decline in mortgage rates. The net rise in house prices subtracted about 19 percent from the index while the small overall decline in incomes reduced affordability by 3 percent.

I also simulated the effect of a one percentage-point increase in mortgage rates to 4.9 percent from the current level of 3.9 percent, assuming home prices and incomes remain steady. Higher borrowing costs would reduce affordability by more than 11 percent. A 1 percent rise in house prices reduces affordability by a bit less than 1 percent, while a 1 percent increase in income adds the same amount. This confirms that housing, a very leveraged investment, is primarily driven by financing costs.

With conditions moving in favor of home ownership and away from rentals, I anticipate a similar shift in housing demand, although residential construction is not likely to grow appreciably. So far this year, investors seem to agree, with a 0.2 percent decline in the apartment REIT sub-index for apartments while the residential single-family component rose 3.5 percent.

There’s market evidence to reinforce this view. In the third quarter, apartment rents fell in San Francisco, New York, Houston and San Jose, the first drops after six years of boom. Nationwide, rent increases slowed for the fourth consecutive quarter, rising 3 percent in the third quarter compared with 5.2 percent in the year-earlier period.

Single-family housing will no doubt attract ample funds from REITs and other sources, now that the bulge of mortgage foreclosures has been eliminated. Also, with fewer households owing more than their homes are worth, more homeowners are able to refinance or purchase new abodes, and fewer will abandon their mortgage commitments.

Despite the bright outlook for REITs and other lenders that concentrate on single-family housing, it’s important to remember that investor zeal for yield has driven money into real estate of all stripes as well as other higher-yielding vehicles such as utility and consumer staple equities, preferred stocks, emerging-market securities and junk-rated bonds.

Many of these investment flows appear overblown, perhaps to the point of irrational exuberance. And note that the guardians of the S&P 500 are not immune to such enthusiasms; recall that in 2001, just after the bursting of the dot com bubble that had exploded the Nasdaq index, they added Information Technology as a subsector.

Monday, September 12, 2016

It's not going to be pretty

We have a situation where most people in Europe and North America have seen declines in their purchasing power for over a decade.

When we get enough perspective—we’re going to find that this whole situation with negative nominal interest rates and with very aggressive monetary policy—has not done much for economic growth, [with] all the confusion this has created.

I wish we could pull out the crystal ball and see what is going to come out of this. I rather suspect that it’s not going to be pretty to go through.

Tuesday, September 6, 2016

Storm coming for financial markets globally

Global growth is weak, and will be eroded further by Brexit. Oil prices are low, and likely to plunge further. The world has excess capacity and a wage-depressing labor surplus. Corporate profits are shaky. And deflation is laying bare the impotence of central banks. So where would you logically expect financial markets to be going, given that economic, financial and political environment?

You’d expect to see increased demand for safe-haven U.S. Treasuries, a soaring dollar, falling commodity prices, and increasing investor aversion to junk bonds, emerging market debt and equities and other low-quality securities. But that’s not the case.

The 10-year Treasury yield has been flat for months, as has the dollar against the euro. Commodity prices in general and oil in particular have risen this year. Money has poured into emerging market bonds as well as junk bonds, depressing their yields. How can current security prices be justified in the face of the fundamental picture, at least as I see it?

Well, maybe they can’t. The most likely outcome to my mind is a major market correction to bring prices back into line with economic fundamentals. Distortions such as negative interest rates and slow economic growth in the face of super-aggressive monetary policies in many countries suggest that things are way out of alignment, and that the resolution may be a very painful process, and a big shock for many market participants.  

Nevertheless, there may be some forces at work that might help explain current market conditions even if they don't justify valuations, which in turn could lessen the blow of an abrupt reversal.

U.S. stocks may still be cheap despite historically high price/earnings ratios. Looking at dividend yields on the S&P 500 index against those available on 10-year government debt, equities remain attractive:

If the dividend yields dropped to match the Treasury yield, the price/earnings ratio of the S&P would be closer to 63 than its current level of about 20. Following this logic, stocks are arguably undervalued by more than 60 percent.

Investors may also take comfort once the U.S. presidential election is settled with a win for Hillary Clinton. Despite all of her baggage of dishonesty, raw ambition and pandering for votes, she’s the devil they know -- and maybe preferable to Donald Trump, the devil they’ve yet to see in action.

There’s also the prospect of a fiscal stimulus program to revive growth. With even central bankers tacitly admitting that monetary policy has failed to generate meaningful economic growth, the pressure on politicians to do their bit will grow, in the euro zone as well as the U.S.

Once a new president is in place, infrastructure spending might be a feasible middle ground for both political parties. The U.S. certainly needs major refurbishing and expansion of roads, bridges, public transportation and other infrastructure. The most recent Global Competitiveness Ranking from the World Economic Forum rates the U.S. third overall in competitiveness but 13th for infrastructure quality as a whole, 14th for roads, 15th for railroads and 16th for electricity supply system. It’s estimated that aging roads and bridges are costing an extra $377 annually per driver. Infrastructure spending would not only create jobs and economic activity but also enhance lagging productivity.

The National Association of Manufacturers calls for major infrastructure spending of $100 billion per year for each of the next three years. It noted that outlays grew 2.2 percent per year between 1956 and 2003, but fell 1.2 percent annually from 2003 through 2012. Total spending for roads and streets fell 19 percent between 2003 and 2012.

Even if the political climate improves after the election, and the spending taps are turned on in the U.S., investors may still be too relaxed about the outlook. The VIX index, a measure of expected future stock market volatility, remains at historically low levels. The S&P 500 index is up about 6.2 percent this year.

But Europe offers an example of what might happen if things reverse. The region’s benchmark Stoxx 600 index is down more than 5 percent this year, erasing almost all of 2015’s gains. In this environment, investors should hold universally large cash positions until there’s a clearer picture of what comes next. 

Thursday, September 1, 2016

Many stock investors do not believe in Treasuries

Many stock bulls haven’t given up their persistent love of equities compared to Treasury's. Their new argument is that Treasury bonds may be providing superior appreciation, but stocks should be owned for dividend yield.

That, of course, is the exact opposite of the historical view, but in line with recent results. The 2.1% dividend yield on the S&P 500 exceeds the 1.50% yield on the 10-year Treasury note and is close to the 2.21% yield on the 30-year bond. Recently, the stocks that have performed the best have included those with above average dividend yields such as telecom, utilities, and consumer staples.

Then there is the contention by stock bulls that low interest rates make stocks cheap even through the S&P 500 price-to-earnings ratio, averaged over the last 10 years to iron out cyclical fluctuations, now is 26 compared to the long-term average of 16.7. This makes stocks 36% overvalued, assuming that the long run P/E average is still valid. And note that since the P/E has run above the long-term average for over a decade, it will fall below it for a number of future years—if the statistical mean is still relevant.

Instead, stock bulls point to the high earnings yield and the inverse of the P/E, in relation to the 10-year Treasury note yield. They believe that low interest rates make stocks cheap. Maybe so, and we’re not at all sure what low and negative nominal interest rates are telling us.

We’ll know for sure in a year or two. It may turn out to be the result of aggressive central banks and investors hungry for yield with few alternatives. Or low rates may foretell global economic weakness, chronic deflation and even more aggressive central bank largess in response. We’re guessing the latter is the more likely explanation.

Monday, August 29, 2016

Why Foreign investors are flocking to US Treasuries

The recent drop in the federal deficit has reduced government funding needs so the Treasury has reduced the issuance of bonds in recent years. In addition, tighter regulators force US financial institutions to hold more Treasury's.

Also, central bank QE has vacuumed up highly-rated sovereigns, creating shortages among private institutional and individual buyers. The Fed stopped buying securities in late 2014, but the European Central Bank and the Bank of Japan—which already owns 34% of outstanding Japanese government securities are plunging ahead. The resulting shortages of sovereigns abroad and the declining interest rates drive foreign investors to US Treasury's.

Also, as we’ve pointed out repeatedly over the past two years, low as Treasury yields are, they’re higher than almost all other developed country sovereigns, some of which are negative. So an overseas investor can get a better return in Treasury's than his own sovereigns. And if the dollar continues to rise against his home country currency, he gets a currency translation gain to boot.

Thursday, August 25, 2016

US Dollar and Treasuries are investment safe havens

We’ve also always liked Treasury coupon and zero-coupon bonds because of their three sterling qualities. First, they have gigantic liquidity with hundreds of billions of dollars’ worth trading each day, as noted earlier. So all but the few largest investors can buy or sell without disturbing the market.

Second, in most cases, they can’t be called before maturity. This is an annoying feature of corporate and municipal bonds. When interest rates are declining and you’d like longer maturities to get more appreciation per given fall in yields, issuers can call the bonds at fixed prices, limiting your appreciation. Even if they aren’t called, callable bonds don’t often rise over the call price because of that threat. But when rates rise and you prefer shorter maturities, you’re stuck with the bonds until maturity because issuers have no interest in calling them. It’s a game of heads the issuer wins, tails the investor loses.

Third, Treasurys are generally considered the best-quality issues in the world. This was clear in 2008 when 30-year Treasurys returned 42%, but global corporate bonds fell 8%, emerging market bonds lost 10%, junk bonds dropped 27%, and even investment-grade municipal bonds fell 4% in price.

Slowing global economic growth and the growing prospects of deflation are favorable for lower Treasury yields. So is the likelihood of further ease by central banks, including even a rate cut by the Fed, as noted earlier.

Along with the dollar, Treasury's are at the top of the list of investment safe havens as domestic and foreign investors, who own about half of outstanding Treasury's, clamor for them.

Wednesday, August 24, 2016

Historical Relationship between Inflation and War

We’ve argued that the root of inflation is excess demand, and historically it’s caused by huge government spending on top of a fully-employed economy. That happens during wars, and so inflation and wars always go together—going back to the French and Indian War, the Revolutionary War, the War of 1812, the Mexican War of 1846, the Civil War, the Spanish American War of 1898, World Wars I and II, and the Korean War. In the late 1960's and 1970's, huge government spending—and the associated double-digit inflation from the Vietnam War topped LBJ’s War on Poverty.

By the late 1970s, however, the frustrations over military stalemate and loss of American lives in Vietnam as well as the failures of the War on Poverty and Great Society programs to propel lower-income folks led to a rejection of voters’ belief that government could aid Americans and solve major problems. The first clear manifestation of this switch in conviction was Proposition 13 in California, which limited residential real estate taxes. That was followed by the 1980 election of Ronald Reagan, who declared that government was the basic problem, not the solution to the nation’s woes.

This belief convinced us that Washington’s involvement in the economy would atrophy and so would inflation. 

Given the close correlation between inflation and Treasury bond yields, we then forecast the unwinding of inflation—disinflation—and a related breathtaking decline in Treasury bond yields to 3%. At that time, virtually no one believed our forecast since most thought that double-digit inflation would last indefinitely. 

We’ve been bulls on 30-year Treasury bonds since 1981 when we stated, “We’re entering the bond rally of a lifetime.” It’s still under way, in our opinion. Their yields back then were 15.2%, but our forecast called for huge declines in inflation and, with it, a gigantic fall in bond yields to our then-target of 3%.

Monday, August 22, 2016

You want to own the longest maturity bond if you believe Interest Rates will go down

We’ve been pretty lonely as Treasury bond bulls for 35 years, but we’re comfortable being in the minority and tend to make more money in that position than by running with the herd. Incidentally, we continue to favor the 30-year bond over the 10-year note, which became the benchmark after the Treasury in 2001 stopped issuing the “long bond.” At that time, the Treasury was retiring debt because of the short-lived federal government surpluses caused by the post–Cold War decline in defense spending and big capital gains and other tax collections associated with the Internet stock bubble.

But after the federal budget returned to deficits as usual, the Treasury resumed long bond issues in 2006. In addition, after stock losses in the 2000–2002 bear market, many pension funds wanted longer-maturity Treasurys to match against the pension benefit liability that stretched further into the future as people live longer, and they still do.

Maturity Matters

We also prefer the long bond because maturity matters to appreciation when rates decline. Because of compound interest, a 30-year bond increases in value much more for each percentage point decline in interest rates than does a shorter maturity bond.

Note that at recent interest rates, a one percentage point fall in rates increases the price of a 5-year Treasury note by about 4.8%, a 10-year note by around 9.5%, but a 30-year bond by around 24.2%. Unfortunately, this works both ways, so if interest rates go up, you’ll lose much more on the bond than the notes if rates rise the same for both.

If you really believe, as we have for 35 years, that interest rates are going down, you want to own the longest-maturity bond possible. This is true even if short-term rates were to fall twice as much as 30-year bond yields. Many investors don’t understand this and want only to buy a longer-maturity bond if its yield is higher.

Others only buy fixed-income securities that mature when they need the money back. Or they’ll buy a ladder of bonds that mature in a series of future dates. This strikes us as odd, especially for Treasury's that trade hundreds of billions of dollars’ worth each day and can be easily bought and sold without disturbing the market price. Of course, when you need the cash, interest rates may have risen and you’ll sell at a loss, whereas if you hold a bond until it matures, you’ll get the full par value unless it defaults in the meanwhile. 

But what about stocks? They have no maturity, so you’re never sure you’ll get back what you pay for them.

via forbes

Wednesday, August 17, 2016

Stocks vs Bonds vs Jeremy Siegel

I was invited by Professor Jeremy Siegel of Wharton for a public debate on stocks versus bonds. He, of course, favored stocks and I advocated Treasury bonds.

At one point, he addressed the audience of about 500 and said, “I don’t know why anyone in their right mind would tie up their money for 30 years for a 4.75% yield [the then-yield on the 30-year Treasury].” 

When it came my turn to reply, I asked the audience, “What’s the maturity on stocks?” I got no answer, but pointed out that unless a company merges or goes bankrupt, the maturity on its stock is infinity—it has no maturity. My follow-up question was, “What is the yield on stocks?” to which someone correctly replied, “It’s 2% on the S&P 500 Index.”

So I continued, “I don’t know why anyone would tie up money for infinity for a 2% yield.” I was putting the query, apples to apples, in the same framework as Professor Siegel’s rhetorical question. “I’ve never, never, never bought Treasury bonds for yield, but for appreciation, the same reason that most people buy stocks. I couldn’t care less what the yield is, as long as it’s going down since, then, Treasury prices are rising.”

Of course, Siegel isn’t the only one who hates bonds in general and Treasuries in particular. And because of that, Treasuries, unlike stocks, are seldom the subject of irrational exuberance. Their leap in price in the dark days in late 2008 is a rare exception to a market that seldom gets giddy, despite the declining trend in yields and related decline in prices for almost three decades.

Stockholders inherently hate Treasuries. They say they don’t understand them. But their quality is unquestioned, and Treasuries and the forces that move yields are well-defined—Fed policy and inflation or deflation are among the few important factors. Stock prices, by contrast, depend on the business cycle, conditions in that particular industry, Congressional legislation, the quality of company management, merger and acquisition possibilities, corporate accounting, company pricing power, new and old product potentials, and myriad other variables.

Also, many others may see bonds—except for junk, which really are equities in disguise—as uniform and gray. It’s a lot more interesting at a cocktail party to talk about the unlimited potential of a new online retailer that sells dog food to Alaskan dog-sledders than to discuss the different trading characteristics of a Treasury of 20- compared to 30-year maturity. In addition, many brokers have traditionally refrained from recommending or even discussing bonds with clients. Commissions are much lower and turnover tends to be much slower than with stocks.

Stockholders also understand that Treasury's normally rally in weak economic conditions, which are negative for stock prices, so declining Treasury yields are a bad omen. It was only individual investors’ extreme distaste for stocks in 2009 after their bloodbath collapse that precipitated the rush into bond mutual funds that year. They plowed $69 billion into long-term municipal bond funds alone in 2009, up from only $8 billion in 2008 and $11 billion in 2007.

Another reason that most of those promoting stocks prefer them to bonds is because they compare equities with short duration fixed-income securities that did not have long enough maturities to appreciate much as interest rates declined since the early 1980's.

Investment strategists cite numbers like a 6.7% annual return for Treasury bond mutual funds for the decade of the 1990's while the S&P 500 total annual return, including dividends, was 18.1%. But those government bond funds have average maturities and durations far shorter than on 30-year coupon and zero-coupon Treasury's that we favor and which have way, way outperformed equities since the early 1980's.

Monday, August 15, 2016

Monetary easing world-wide and more on the way

In response to Brexit, the Bank of England has already eased, not tightened, credit with more likely to follow. The European Central Bank is also likely to pump out more money as is the Bank of Japan as part of a new $268 billion stimulus package. Meanwhile, even though Fed Chairwoman Yellen has talked about raising interest rates later this year, we continue to believe that the next Fed move will be to reduce them.

Major central banks have already driven their reference rates to essentially zero and now negative in Japan and Europe while quantitative easing exploded their assets. The Bank of England immediately after Brexit moved to increase the funds available for lending by UK banks by $200 billion. Earlier, on June 30, BOE chief Mark Carney said that the central bank would need to cut rates “over the summer” and hinted at a revival of QE that the BOE ended in July 2012.

via John Mauldin, Forbes

Monday, August 8, 2016

More QE and loose monetary policies could be ahead in US and Europe

Several years of rock-bottom interest rates around the world haven't been all bad. They've helped reduce government borrowing costs, for sure. Central banks also send back to their governments most of the interest received on assets purchased through quantitative-easing programs. Governments essentially are paying interest to themselves.
Janet Yellen - Chairwoman of US Federal Reserve

What is Helicopter Money? 

Since the beginning of their quantitative-easing activities, the Federal Reserve has returned $596 billion to the U.S. Treasury and the Bank of England has given back $47 billion. This cozy relationship between central banks and their governments resembles “helicopter money,” the unconventional form of stimulus that some central banks may be considering as a way to spur economic growth.

I’m looking for more such helicopter money -- fiscal stimulus applied directly to the U.S. economy and financed by the Fed --no matter who wins the Presidential election in November.

It’s called helicopter money because of the illusion of dumping currency from the sky to people who will rapidly spend it, thereby creating demand, jobs and economic growth. Central banks can raise and lower interest rates and buy and sell securities, but that’s it. They can thereby make credit cheap and readily available, yet they can’t force banks to lend and consumers and businesses to borrow, spend and invest. That undermines the effectiveness of QE; as the proverb says, you can lead a horse to water, but you can't make it drink.

Furthermore, developed-country central banks purchase government securities on open markets, not from governments directly. You might ask: "What’s the difference between the Treasury issuing debt in the market and the Fed buying it, versus the Fed buying securities directly from the Treasury?" The difference is that the open market determines the prices of Treasuries, not the government or the central bank. The market intervenes between the two, which keeps the government from shoving huge quantities of debt directly onto the central bank without a market-intervening test. This enforces central bank discipline and maintains credibility.

In contrast, direct sales to central banks have been the normal course of government finance in places like Zimbabwe and Argentina. It often leads to hyperinflation and financial disaster. (I keep a 100-trillion Zimbabwe dollar bank note, issued in 2008, which was worth only a few U.S. cents as inflation rates there accelerated to the hundreds-of-million-percent level. Now it sells for several U.S. dollars as a collector’s item, after the long-entrenched and corrupt Zimbabwean government switched to U.S. dollars and stopped issuing its own currency.)

Argentina was excluded from borrowing abroad after defaulting in 2001. Little domestic funding was available and the Argentine government was unwilling to reduce spending to cut the deficit. So it turned to the central bank, which printed 4 billion pesos in 2007 (then worth about $1.3 billion). That increased to 159 billion pesos in 2015, equal to 3 percent of gross domestic product. Not surprisingly, inflation skyrocketed to about 25 percent last year, up from 6 percent in 2009.

To be sure, the independence of most central banks from their governments is rarely clear cut. It’s become the norm in peacetime, but not during times of war, when government spending shoots up and the resulting debt requires considerable central-bank assistance. That was certainly true during World War II, when the U.S. money supply increased by 25 percent a year. The Federal Reserve was the handmaiden of the U.S. government in financing spending that far exceeded revenue.

Today, developed countries are engaged not in shooting wars but wars against chronically slow economic growth. So the belief in close coordination between governments and central banks in spurring economic activity is back in vogue -- thus helicopter money.

All of the QE activity over the past several years by the Fed, the Bank of England, the European Central Bank, the Bank of Japan and others has failed to significantly revive economic growth. U.S. economic growth in this recovery has been the weakest of any post-war recovery. Growth in Japan has been minimal, and economies in the U.K. and the euro area remain under pressure.

The U.K.'s exit from the European Union may well lead to a recession in Britain and the EU as slow growth turns negative. A downturn could spread globally if financial disruptions are severe. This would no doubt ensure a drop in crude oil prices to the $10 to $20 a barrel level that I forecast in February 2015. This, too, would generate considerable financial distress, given the highly leveraged condition of the energy sector.

Both U.S. political parties seem to agree that funding for infrastructure projects is needed, given the poor state of American highways, ports, bridges and the like. And a boost in defense spending may also be in the works, especially if Republicans retain control of Congress and win the White House.

Given the "mad as hell" attitude of many voters in Europe and the U.S., on the left and the right, don't be surprised to see a new round of fiscal stimulus financed by helicopter money, whether Donald Trump or Hillary Clinton is the next president.

Major central bank helicopter money is a fact of life in war time -- and that includes the current global war on slower growth. Conventional monetary policy is impotent and voters in Europe and North America are screaming for government stimulus. I just hope it doesn’t set a precedent and continue after rapid growth resumes -- otherwise, the fragile independence of major central banks could go the way of those in banana republics.

Monday, July 25, 2016

Gary Shilling interview with WindRock Wealth

Topics include 
- Negative Interest Rates are being promoted by some Central Banks to encourage borrowers to borrow money.
- Further leg down in oil prices could cause financial disruption due to high leverage
- Dollar upward move will continue for a long time
and MORE

Tuesday, July 5, 2016

Fed will not raise rates this year

I said in our Insight newsletter early in the year that I thought the next move of the Fed would be to cut rates not to increase them. They seemed to increase rates 25 basis points-a quarter of a point-last December I think because they've been crying wolf so long their credibility was disappearing. They've been talking about a stronger economy...and, as a result, they've been forecasting that they would raise rates. I mean if you go back a couple of months they in effect said they were going to raise rates four times this year and now it looks like they may raise once or maybe not at all...

But now they look around, labor markets are certainly weak. The latest numbers for last month were extremely low with 38,000 payroll employment-that's a long way from the 200,000 average, which is none too great to begin with and the unemployment rate dropped from 5% to 4.7% but that was only because people dropped out of the labor force-they gave up and quit looking for jobs. So we've got a situation now where labor markets are weak and inflation is low, if not going into deflation, and then the Fed is now paying a lot more attention to the rest of the've got a lot of factors that I think are convincing the Fed that they are, if anything, not going to raise them.

Thursday, June 30, 2016

OPEC is a cartel and why Oil could fall to $10

Cartels exist to keep prices above equilibrium-that's the only reason for that-and that encourages cheating; somebody in or out of the cartel wants more than their share and so the leader of the cartel's job is to cut its own production to accommodate the cheaters. 

Well, the Saudis-the leader of the OPEC cartel-decided that they were not going to go along with that. They thought they could outlast others and when you're in a price war, the cost of meeting budgets isn't the number that counts. It's the point where free cash flow disappears and that in the Permian Basin in Texas is $10 to $20 a barrel and it's even less in the Persian Gulf.

Wednesday, June 29, 2016

Foreign investors love US Treasuries

Treasuries have a tremendous safe-haven appeal. Foreigners, when times are tough, go to Treasuries... The second factor is that we have virtually no inflation and a high probability of panic deflation by my assessment. And the third interesting factor is Treasury yields, as low as they are, are much higher than those of almost every other developed country. You look now and Germany is negative; Japan, they're negative. 

So, for European investors, they basically can invest in Treasuries and pick up a yield spread and if the dollar rallies, as I think it will, they get a double whammy because they get more yen or more euros when they convert that back into their own currency.

Tuesday, June 28, 2016

Debt to Income ratio is an indication of more deleveraging to come

If you simply look at the rate in which the deleveraging has taken place so far, it could actually take another 6 or 8 years. 

Now that's just putting a ruler on trend. 

I think, for example, consumer debt in this country-household debts from credit cards, student loans, auto loans in relation to assets to after-tax income, which is normally how you look at it-the norm was 65 percent debt-to-income. In the early 80's it took off to 130 percent and it's now down to 104 percent so it's a long way from the norm and, as I say, if you just project where we are it could take another 6 or 8 years.

Wednesday, June 8, 2016

Monday, June 6, 2016

India has many advantages over China

When Narendra Modi, the Prime Minister of India, speaks to a joint session of the US Congress on 8 June, he may find it hard to convince lawmakers of his country’s promise. He shouldn’t: As China, Russia and Brazil slow down, India is barreling ahead. It’s one of the brighter spots among all the emerging markets.

True, India’s economic growth in the last 25 years has been slower than China’s. India’s growth rose to almost 11% of US gross domestic product in 2014 from about 4% in 1990, while China’s vaulted to 60% from 9% in the same period. But unlike China, India never became an export-driven manufacturing juggernaut and so its growth has been steadier. Last year it was 7.5%.

India also didn’t benefit as much as China when manufacturing shifted from the West to developing countries, and thus the decline in offshoring is hurting India less than China.

India certainly has its problems—notoriously slow bureaucracies, a lack of good infrastructure, and too much regulation and corruption to name a few—that need to be addressed before economic growth can explode. Modi has sought reforms for many of these issues, though with limited success so far.

Reliable data measuring India’s economy are fuzzy, to say the least. Most businesses are tiny and unregulated; many people are employed off the books. India also uses wholesale, not final, prices to deflate nominal GDP. Due to lower oil prices, the wholesale price index has been falling for 17 straight months while retail prices are still rising at a 5% annual rate. So the reported real GDP numbers are overstated.

Still, India has major advantages over China. China’s one-child policy, while now relaxed, will result in fewer entrants into the labour force for decades. That could choke growth: Younger people tend to be more geographically mobile and flexible in terms of occupation and ability to learn new skills.

By contrast, India has had few constraints on population growth. The dependency ratio—the number of children and seniors relative to the working-age population—will continue to fall in India as it rises in China. As of 2015, India had 1.25 billion people versus China’s 1.37 billion. It won’t be long before India’s population is bigger.

Say what you want about colonialism, but British control of India for centuries left a vigorous democracy and a parliamentary form of government, which is useful for running a large, diverse country.

The British also left India with a railway system that facilitates the movement of people and goods over a vast geography. By contrast, China is reluctant to grant resident status to farmers who move to urban areas in search of work.

And of course the British gave India the English language—useful in a world that conducts most business in English and as a unifying force in a country with hundreds of languages and dialects. India also inherited a free press and a legal system from the UK. As a result, India’s rule of law is vastly better than the Communist party-dominated courts of China, complete with show trials and forgone convictions.

All of these advantages have led to large, sophisticated companies, such as the Tata complex, that compete globally. China, on the other hand, is burdened with government-controlled banks and other inefficient, state-owned enterprises that still produce half the country’s output and employ a quarter of the workforce.

For the first half-century of independence, Indian politics were dominated by the Congress Party with its socialist orientation and attempts to emulate the Soviet Union. In the 1950s, steel, mining, water, telecommunications and electricity generation were effectively nationalized.

The Industries Act of 1951, which required all businesses to get licenses from the government before they could launch, expand or change their products, stifled innovation. The “licence raj” reigned. The government imposed import tariffs in the name of encouraging domestic production, and domestic firms were prohibited from opening foreign offices. Foreign investment dried up under stringent restrictions.

As a result, manufacturing never blossomed and the economy grew at what Indian officials accepted as the “Hindu rate of growth” of 3% to 4%—subpar for a developing economy—while other Asian economies blossomed. Between 1950 and 1973, the Indian economy annually grew 3.7 percent, or 1.6 percent per capita. Japan’s economy grew 10 times faster and South Korea’s five times faster. China grew at a sustained 8 percent annual rate. All that began to change dramatically in 1991 with the shift toward capitalism.

Even so, India has historically had more of a free-market orientation than other large, developing countries, notably Russia and China. Its film industry, Bollywood, cranks out movies that range from excellent to awful, while in China, films are propaganda tools. State-controlled enterprises in India account for only 13% of GDP compared with 29% in China.

Fortunately for India, the pharmaceutical and technology sectors never suffered the burdensome regulations that bogged down the steel and airline industries. Also helpful is the Indian natural bent toward technology. Its booming information-technology sector relies more on new technologies such as satellite transmission, and is able to leapfrog Indian-regulated utilities and the crumbling infrastructure.

American and European firms outsource many back-office and even legal and medical services to India. Outsourcing revenue is now $95 billion a year and accounts for a fifth of Indian exports. India’s lower wages and English-speaking ability are the attractions.

Many Indians have strong entrepreneurial inclinations, and the economic growth they can spark is vital to reducing high poverty rates and corruption as economic power shifts from politicians to entrepreneurs. But many reforms are still needed. Bribe demands are routine, the bureaucracy is byzantine and the infrastructure is backward. All of this impedes entrepreneurial activity.

India also has a culture that penalizes risk-taking. Business is concentrated among long-existing and well-connected conglomerates with close ties to the government, much like the state-owned enterprises in China and the chaebols in South Korea.

When it comes to the cost of starting a business, India is off the charts—ranked 173rd out of 189 countries, according to the World Bank—compared with the US, Germany, the UK and even China. Only China tops India for the amount of time it takes to start a company. India also ranked 130th for the ease of doing business, behind the notoriously difficult Russia (51st) and Brazil (116th). Even China, at No. 84, ranks higher.

Opening the economy to entrepreneurs remains a long-run challenge for India, as does the education of hundreds of millions of students. About 90% of children enter school but more than half drop out before completing high school. Cheating on tests and bribing teachers for passing grades is rampant.

China is moving slowly to open its financial and currency markets to foreigners. The yuan, however, remains tightly controlled. It’s allowed to appreciate in good times but is held stable whenever the economy is weak. The rupee, by contrast, has been relatively free of government intervention. The Reserve Bank of India, the central bank, is largely independent of government influence, while the People’s Bank of China is completely government controlled.

In contrast to China’s 36% consumer spending component of GDP in 2014, India’s consumers are responsible for 59% of the economy, despite an equally high savings rate. This is a better balance in a world where exports and capital spending are no longer the easy route to economic growth for developing countries. India’s exports were a sizable 23% of GDP in 2014, and that percentage had risen despite the global recession and slow recovery. Chinese exports, on the other hand, were about the same percentage of GDP—much lower than the 35% level in 2006.

Change comes slowly to India, whose culture is heavily influenced by a Hindu philosophy that doesn’t emphasize urgency. Hinduism teaches that after death comes reincarnation in another form of life, so Hindu followers don’t need to get everything accomplished in this life since they can get more done in later lives.

But with improved education, faster deregulation and other reforms, India’s many advantages could translate into higher productivity and faster economic growth than in China. That should be Modi’s message when he visits America next week.