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."