Sunday, March 16, 2014

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Material in this post does not constitute investment advice or a recommendation and do not constitute solicitation to public savings. Operate with any financial instrument is safe, even higher if working on derivatives. Be sure to operate only with capital that you can lose. Past performance of the methods described on this blog do not constitute any guarantee for future earnings. The reader should be held responsible for the risks of their investments and for making use of the information contained in the pages of this blog. Trading Weeks should not be considered in any way responsible for any financial losses suffered by the user of the information contained on this blog.

The Sanctions Boomerang Begins: Why $105 billion of Treasuries Went Missing

by Wolf Richter

Another warning shot was fired before an all-out assault on the dollar system begins. This time, an official shot: Alexey Ulyukaev, Russia’s Minister of Economic Development and former Deputy Chairman of the Central Bank, fired it. It was a major escalation, Valentin Mândrăşescu, editor of The Voice of Russia’s Reality Check, told me from Moscow.

Last time, it was Sergei Glazyev, an advisor to Vladimir Putin who’d fired the shot. But he wasn’t a government official. “Anonymous sources” at the Kremlin claimed he wasn’t speaking for the government. As Mândrăşescu reported in his excellent article, From Now On, No Compromises Are Possible For Russia:

From the economic point of view, everyone should get ready for tough actions from Moscow. Sergei Glazyev, the most hardline of Putin’s advisors, sketched the retaliation strategy: Drop the dollar, sell US Treasuries, encourage Russian companies to default on their dollar-denominated debts, and create an alternative currency system (reference currency) with the BRICS and hydrocarbon producers like Venezuela and Iran.

Unlike radical-sounding Glazyev, Ulyukaev is part of Dmitry Medvedev’s Cabinet. And as former Deputy Chairman of the Bank of Russia, he doesn’t take currencies lightly. He told Rossia-24 news channel about possible retaliatory measures if Washington adds economic sanctions to the political sanctions. Moscow wouldn’t worry too much about political sanctions, he said, but if Washington tries to hurt Russia’s economy, Moscow would retaliate by targeting the US dollar.

Some of it is already happening

Washington’s decision to release a minuscule 5 million barrels of oil from the Strategic Petroleum Reserve caused the price of oil to tank – a direct attack on the main revenue source of the Russian government, and a sign that Washington is willing to hit where it hurts the most [read a trader’s lament.... Commodity Markets Will Be Used As A Weapon Against The Putin Regime, Starting Now].

Russia instantly retaliated, it seems. Suddenly, there was a mysterious mega-plunge of $104.5 billion in US Treasuries held in custody by the Federal Reserve during the reporting week ended March 12. It brought the balance down to $2.86 trillion. These securities are owned by foreign countries. As of the US Treasury’s December statement, the most recent available, the Fed held $138.6 billion in Treasuries that belonged to Russia – down by $22.9 billion from a year earlier. The mega-plunge of $104.5 billion? No data is available yet to confirm these securities belonged to Russia. And if they did, it’s unlikely that Russia dumped them on the market, but it could have transferred them to another banking center, such as Luxemburg, to get them out of reach of the US government, and be able to dump them at an opportune moment.

Getting out from under the dollar

Russia has been palavering with other countries about initiating alternatives to the dollar. Formal plans emerged from the Kremlin last May on how Russia wanted the BRICS to dismantle the dollar system. So now it was Ulyukaev, an official heavy-weight, who said that Russia would work on increasing the volume of international trade denominated in national currencies, thus bypassing the dollar (translation by Mândrăşescu):

“Why should we have dollar contracts with China, India, Turkey?” he said. “Why do we need this? We must have contracts in national currencies. And this applies to energy and other spheres.” The focus would be on Russian oil and gas companies. “They must be braver in signing contracts in rubles and the currencies of partner-countries,” he said. “I think now there is an additional impetus to finally finish this job.”

And the “currency reserve policy” would need some adjustment with maximum focus on “local currencies”; it was the normal way, he said. In Mândrăşescu’s analysis, Ulyukaev was outlining an attack on the petrodollar system and the enormous advantages it confers on the US, with the goal of creating parallel petro-currencies.

Media blackout in the US

The warning, issued officially and publicly by a Cabinet member, to target the dollar, has been vigorously ignored by the mainstream media in the US. It’s a touchy subject here. The dollar reigns supreme. Its status as the sole world reserve currency, which has provided the US with enormous economic advantages, remains unquestionable forevermore. Or so wishes the Fed, which has done such a wonderful job of managing the dollar for the last 100 years that it has lost most of its value, though it’s still a heck of a lot better than the ruble.

“I have a suspicion the Western media don’t want to report on this,” Mândrăşescu said. “It could be a bit unpleasant for the S&P 500 and the nanobots trading the US stock market.” Better keep them in the dark.

It took a while. But it had to come, the public warning shot – after some ferocious lobbying behind closed doors. No one in Germany is allowed to get in the way of the sacrosanct exporters.

See the original article >>

Weighing the Week Ahead: Yellen Takes the Stage

by Jeff Miller

Rightly or wrongly, markets continue the Fed fixation. Many expect (or demand?) a change in Fed policy. This week marks the first FOMC meeting with Janet Yellen as the Chair. Since there will also be an update to forecasts, the announcement will include a press conference. With some fresh data and plenty of news since the last meeting, my theme for this week:

Fed Chair Yellen will take center stage.

Last Week's Theme Recap

I expected last week's theme (in the absence of much real data) to be focused on a parade of pontificating pundits. That was very accurate. As predicted, there were many articles of the laundry list type. That is where the pundit or journalist starts with a scary theme that can be expected to be popular and then looks back to find some similarities with the past. What a joke! Suppose you had a group of summer interns. Ask them to take any year in history and read newspapers, listing anything that is similar to current times. They will deliver.

Most people have a low bar for research findings, particularly when it suits their own conclusions.

This is a perfect illustration of the reason for my weekly post – planning for the week ahead. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

This Week's Theme

How should we get ready for this week's Fed announcement? There are three basic positions:

  1. Rate hikes might come faster than expected. This is for one of two main reasons:

    1. Lower labor force participation (Matthew Boesler at BI).
    2. Lower growth potential (Morgan Stanley's Vince Reinhart via Joe Weisenthal).
  2. There is plenty of labor slack from cyclical forces, suggesting the need for patience. Fed expert par excellence Tim Duy explains in a thoughtful article with many charts. It defies summary, so those who want to understand need to read it.
  3. Status quo. See Chicago Fed President Charles Evans. (Via Reuters).

We will probably start the week with breaking news from Ukraine, but by Wednesday our focus will, once again, be on the Fed.

I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
  2. It is better than expectations.

The Good

In a light week for data, there was some good news.

  • Earnings growth remains solid – both reported and forecast. The last quarter of 2013 approached the 10% growth predicted by Brian Gilmartin and few others. In Brian's most recent update he highlights the three time frames you should use when thinking about earnings growth:
  1. The quarter being reported, i.e. q4 '13, is very robust. Hard to argue with +9.8% y/y earnings growth;
  2. The quarter within which we currently reside, which starts getting reported early April '14. Current consensus estimate of +2%, will likely decline over the next 3 weeks, and then by mid-May, once the majority of companies report, we will likely end up between 4% – 5%, maybe better;
  3. Full-year '14, which like q1 '14 has been impacted by weather. I think the 2nd half of '14 will be stronger than the first half of '14.
  • Retail sales beat expectations with a gain of 0.3% and 1.5% YoY. The monthly result was less impressive when considering revisions to the prior months. Calculated Risk notes that the YoY gain is 2.2% if you exclude gasoline sales. Doug Short has a great chart package. This one shows why the most recent update is (perhaps) not so exciting:

  • The number of US millionaires is at a new high – 9.63 million versus 9.2 million in 2007. (LA Times).
  • Initial jobless claims hit a new low – 315,000. It is a noisy series, but this is encouraging.
  • Job turnover data remains positive. It was in line with expectations, but as Calculated Risk notes, it confirms a positive trend. The two things to watch are job openings and the quit rate (higher quits are very positive). You can see both from this chart:

The Bad

There was also some bad news.

  • High frequency indicators continue to be weaker. I always read carefully the fine weekly summary from New Deal Democrat. He collects many concurrent indicators that each might seem minor, but collectively are quite significant. He documents a continuing overall soft patch.
  • Copper prices are in a dramatic decline. The market seems to be reacting to this news. Some even infer a global recession from the recent message from "Dr. Copper." The current pricing is heavily influenced by China – important, but not necessarily the only global factor. Dr. Ed prefers the CRB to copper, and discusses other factors as well. Here is the Yardeni chart:

  • More Americans see Russia as a threat – 69% according to a CNN poll. 40% also fear a nuclear war with Russia. (If you share this fear, how should you invest? Answer in the conclusion.)
  • Michigan sentiment disappointed. I regard this as an important indicator for both employment and consumption. It is time for a fresh look at my favorite chart of this data series, one that combines the history, GDP, recessions, and the average level. Naturally, it is from Doug Short.

  • Ukraine developments. Regardless of one's interpretation of events, the market will definitely interpret added tensions as negative. Stories about troop movements to the Crimean border will definitely rile the markets. As has been the case for the last two weeks, anything I write can be obsolete by the time you read it. Separate your interest as a citizen from your decisions as an investor. I have heard several stories about people who sold all of their stocks because of these events. In addition to the excellent sources I have provided over the last two weeks, I recommend this article by William A. Watts of MarketWatch. It emphasizes the investment perspective. I love the comment from my friend and colleague Scott Rothbort, who writes a daily "Gut Feeling" column on the markets: This is a game of chess, not battleship.

The Ugly

9/11 planner released in a prisoner swap – now moved to Germany where the statute of limitations on terrorism is ten years. (Full story at The XX Committee).

Humor

We all deserve some laughs. Some of the most popular blog posts provide the humor that lends perspective to what is happening.

Bespoke's premium service analyzed the over-reaction to small market moves (via Dorsey Wright).

And Josh Brown's list of "explanations" for Thursday's selling was a big hit. Check out his full list, but here are my favorites:

Fox Business: Obamacare

CNBC: It didn't sell off at all, it was actually a reverse rally

Forbes: Taxes are too high

Huffington Post: Taxes are too low

Fox News: Gay marriage

Motley Fool: Sign up here to find out!

Bloomberg TV: The opposite of whatever CNBC said.

StockTwits: Here's a chart

USA Today: Let's take a poll

Zero Hedge: Better question, why would it have gone up?

Business Insider: Ten reasons, actually (view as single page?)

Financial Times: Please take a moment to register and accept cookies

MarketWatch: 1929

If you are a regular reader of these sources, you will be laughing.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his newest recession indicator, maintaining an increase in the "weeks to recession" from 26 to 27. This does not mean that there will be a recession in 27 weeks. Instead, it shows that the chance is "statistically remote" that a recession would start during that time. Georg's BCI index also shows no recession in sight. For those interested in gold, Georg also sees a possible buy signal next month. Stay tuned!

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI, you should be reading this update.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." None so far – and Bob has been far more accurate than the high-profile punditry.

David Rosenberg's indicators suggest no recession and probably two more years of growth. His analysis will sound familiar to our regular readers, since it has been our message for almost three years:

For Rosenberg, the central question is whether the U.S. economy will relapse into a recession. Once you answer that question, he said, you can debate the direction of the equity and fixed-income markets.

The U.S. economy is incredibly resilient, he said, and he agreed with the adage that a recovery never "dies of old age."  It takes a "negative shock" to start a recession, he said - "and those always have the Fed's thumbprint on them."

A severe foreign-based shock is unlikely to derail U.S. growth, he said. Rosenberg noted that our economy and markets had good performance following the Asian crisis in 1997.

The Week Ahead

After a week of light data, this week is more normal.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on the most important subject. Confirmation for new lows?
  • Housing starts and building permits (T). Housing could be an economic driver. These are leading indicators.
  • Industrial production (M). February data for a key GDP component.

The "B List" includes:

  • Existing home sales (Th). Less important than new construction, but still a good measure.
  • Leading indicators (Th). Still widely followed.
  • CPI (T). With no signs of inflation, this remains a secondary indicator.
  • Fed stress test results (Th – after the close). Some background here.

The FOMC announcement on Wednesday followed by Yellen's first press conference will be the big event for the week. I am less interested in the regional Fed results.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Three weeks ago Felix made a dramatic switch from neutral to bullish adding trading positions throughout the week. That has worked pretty well. We remain fully invested. Many sectors have returned to the penalty box, reflecting reduced overall confidence in the three-week forecast.

It has been tougher than ever for traders, and that is saying a lot. This Taiwan Stock Exchange study says that "Less than 1% of the day trader population is able to predictably and reliably earn positive abnormal returns net of fees."

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

This is still an important time for long-term investors. We all know that market corrections of 15% or so occur regularly without any special provocation. Recent years have been the exception. Over the last several weeks I have emphasized the need to maintain perspective, using market declines to add to positions.

It helps if you have been actively rebalancing your portfolio and trimming winners. Then you have some cash. Some readers have asked me to write more on this topic, so I have placed it on the agenda. For now, let me do a quick summary.

  1. Review your holdings regularly. (For me, that means at least weekly, but it is my job. Quarterly is probably enough for most people, perhaps with some price alerts). Make sure that your original reasons for the investment are still valid. Revise your fair value and price target estimates.
  2. Do not fall in love with a position. If hanging on to a disappointing holding, make sure your reasons are sound.
  3. Sell if your price target is hit.
  4. Rebalance by trimming if a stock appreciates massively, but remains below the price target.

Each week I highlight some of the best advice I see. Here are some highlights.

Eddy Elfenbein has a typically level-headed analysis about what long-term investors can expect from stocks: 5% in real terms, half from capital appreciation and half from dividends. If you expect some inflation, you need to add that. Stocks are a good inflation-fighter. Read the full post for comparisons with some recent bearish arguments. If you are a good picker of stocks, you might add a little to that.

Value Line's famous strategist, Sam Eisentadt, sees another 12% in stocks before September. No guarantees of course, but he asks if anyone has a method with a better track record for six-month changes. (Via Mark Hulbert).

Barry Ritholtz addresses the issue: How Market Tops Get Made

This is a good analysis of key factors developed over decades of research, so read about each. Here is a key quote:

What does all this mean for the current run? According to Lowry's, "the weight of evidence continues to suggest a healthy primary uptrend with no end in sight." For those concerned with a market top, that is rather bullish.

A few caveats about Desmond's studies: Although he is rigorous and empirically driven, these data points all come from past market behavior. There are no guarantees that in the future, markets -- that means you, Humans -- will continue to operate the same way. Perhaps the changing structure of markets might impact market internals. Maybe the rise of ETFs will have an impact. Regardless, there are no guarantees the bull will continue.

However, based on the data Desmond follows, he makes a fairly convincing case that this bull market still has a ways to go before it tops out.

Steven Russolillo of the WSJ takes on the same topic with a checklist from Strategas Research Partners:

Why choose these sources to highlight? Integrity. Using indicators that have worked for years. This is in sharp contrast to those who start with a viewpoint and switch whenever the indicator no longer works. In a continuing exercise in futility, I wrote about this topic last week here and here. Most people would prefer to be scared witless (TM OldProf). Which leads to…..

And finally, most Americans have missed the rally – so far—according to Bloomberg. If that describes you, you have company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love and use feedback).

Final Thought

I am well aware of the difference between perceptions and reality. The former is of greater interest to traders. Many of them have been caught off base (switching metaphors for the new season) and blame the Fed for their own mistakes. (See Fed as a Fig Leaf).

The reality is that the current QE rendition is having only a small economic effect and it will matter little when it goes. (See my QE summary.)

One of my regular themes is the over-emphasis on the Fed rather than economic fundamentals --- earnings, recession risk, and potential financial stress. That focus will pay off for long-term investors.

See the original article >>

Time To Buy China?

by James Gruber

The bear case
Questions for bears
The case for accumulating
Risks
What to buy

Late last year, Asia Confidential made a seemingly outrageous call: that junior gold miners would likely prove the great contrarian trade of 2014. At the time, these stocks were the most hated assets on the planet. By a distance. But valuations were at more than decade lows. And many companies were addressing shareholder concerns by booting out bad management, cutting costs and overly-aggressive capital expenditure, as well as focusing more on returns on capital instead of growth. Gold prices didn’t need to rise for many of these companies to provide potentially attractive returns as they were discounting US$700/ounce prices into perpetuity. Since that call, the junior gold miners ETF in the US has rebounded close to 50%.

These miners no longer offer the same compelling “deep value” buying opportunity (though still reasonable). The question for investors now is: what assets do offer such opportunities? Well, Russian stocks may qualify given Ukraine worries have driven market valuations down to a seemingly cheap 5x price-to-earnings ratio. Though tread carefully given earnings and book values have been “juiced” by a 13-year oil bull market. Copper miners may be worth a look also given the extraordinary price action in the copper price of late.

Our focus today though is whether China stocks qualify as potential opportunities following their recent correction. It’s our view that these stocks do offer attractive prospective returns. Not outstanding, but attractive. In other words, long-term investors should consider accumulating them at current levels.

Yes, China’s economy is deteriorating. I’ve been consistently negative on this economy over the past 18 months. But the argument here is that a credit bust is now largely factored into stock prices. The Chinese stock market is down two-thirds from 2007 highs, investor sentiment is at multi-year lows, valuations are close to decade lows and bank prices have more than discounted a crisis.

Sure, there are plenty of risks to this call. Stock market corrections normally end with sharp falls and that may be ahead of us. Events such as further trust loan defaults and a serious property downturn (the next domino to fall) could further dent investor confidence. And the list goes on. Ultimately, however, these risks need to be weighed against the price on offer. In the case of Chinese stocks, the price appears reasonable.

The bear case
The bear case for China stocks is an easy one to make. As almost everyone is making it, I’m not going to bore you with all the gory details. Suffice to say, the case largely rests on these key factors:

1) China is undergoing a credit bust which will almost certainly worsen. As famous short-seller Jim Chanos likes to say with a hyperbolic flourish: China is Dubai 2008 multiplied by 1000.

For some context, let’s turn to a prior post of ours:

“It’s important to understand how China’s economy got to be so big in a short space of time. The speed of economic ascent has no parallel in modern times and it’s been the result of a classic export-led growth model.

What this means is that China has been able to mass produce goods on an unprecedented scale given the appetite for these goods abroad. This has helped lift industrial investment well beyond the level which would be needed if it focused solely on the domestic market. And it’s been aided by a key competitive advantage on the global stage: cheap labor. The end result has been that China has been able to suppress domestic demand and pour resources into investment.

The reason why this export-led model is unsustainable is that China now produces so many goods that the rest of the world cannot possibly absorb them all. China’s gotten to big for its own good, in crude terms.

When the 2008 financial crisis hit, Chinese exports plummeted and the limits of the model became apparent. However, China cushioned the blow by implementing massive stimulus measures. In effect, it sunk even more money into investments, such as infrastructure, property and factories. The problem to this day is there hasn’t been the end-demand for these investments. In other words, export demand has remained soft and domestic demand for goods hasn’t been able to pick up the slack.

And a bigger problem is that the much of the investments via the stimulus were debt-financed, principally to state-owned firms. These firms were deemed less risky by banks.

That’s created an issue for small firms which haven’t had access to bank financing. Given reduced export and domestic demand, they’ve had to resort to financing from outside the banks, the so-called shadow banking system. They’ve had to pay much higher interest rates as a consequence. And it’s widely known that the collateral used for non-bank financing is less-than-solid, on average.”

The reliance on debt to push economic growth has resulted in total China credit to GDP reaching 220%. That means China is now heavily dependent on credit to produce growth.

The worry is not so much the total amount of debt, but the pace at which it’s been accumulating. China credit to GDP has risen by 90 percentage points over the past years, nearly 2x that of other countries prior to financial crises.

Fitch -Trends in Pre-Stress Credit to GDP

In short, history suggests rapid accumulation of credit almost always results in serious financial crises. And China’s unlikely to be any different.

2) The history of transitions away from export-led economic models also makes for ugly reading.

Everyone, including the Chinese leadership, knows that China needs to rebalance the economy more towards domestic consumption. Similar transitions in Japan in 1973 and South Korea in 1991 though led to sharp slowdowns in economic growth.

Investment transitions chart

3) Recent economic data has shown the downturn is gathering pace. Industrial output slowed to 8.6% year-on-year (YoY) for the first two months of 2014, down from 9.7% in December and missing consensus forecasts of 9.5%. Industrial output tracks GDP pretty closely and it was the lowest output reading since August 2009.

Property sales were also disappointing, down 3.7% YoY in January and February combined. And fixed asset investment and retail sales growth slowed too.

There’s little doubting it: China’s economy is swiftly slowing.

4) Further trust defaults are coming. Just over a week ago, the government refrained from rescuing struggling solar cell company, Chaori, after it couldn’t make an interest payment on its bond. This was the first corporate bond default in China’s history.

The fear is that more defaults are coming with 40% of trust loans due to mature during the remainder of 2014. Bank of America Merrill Lynch says the next high risk period for defaults is April through July.

5) Implementation of economic reforms would be a net-negative for GDP growth in the near term. If China is determined to slow investment growth, that’ll inevitably lead to lower economic growth. After all, investment growth has averaged 15% over the past decade, while consumption growth has averaged 9%. Slowing down investment growth means consumption would need to lift significantly for GDP to maintain current rates. And that’s unlikely to happen.

Questions for bears
Here’s the thing: your author agrees with all of the above. And I’ve repeatedly made the case for a China credit bust.

But investing based purely on past or future economic conditions is a tricky and often fruitless game. A recent study by Credit Suisse showed that if you’d invested in emerging markets based on past GDP growth rates, your subsequent market returns were poor. In fact, the countries with the lowest GDP growth have subsequently performed best.

CS GDP & stock market returns

What explains this? Well, it’s simply that countries with low economic growth often have that factored into stock market valuations, and vice versa. It’s the price that you pay for the growth that matters.

This is consistent with data which I’ve seen on the China market. My previous firm back-tested many factors driving China stock market returns and so-called value investing consistently beat other investment styles, including momentum, over short and long-term periods.

In sum, there’s a reason why the vast majority of economists make poor investors. They can make perfect predictions about an economy, including a China credit bust, and still get the stock market wrong.

Price and valuation are the ultimate drivers of future returns. That’s doesn’t mean economic prospects should be ignored though as these can form important inputs on whether risks, particularly tail risks, are factored into valuation.  

The case for accumulating
Our call to start accumulating China stocks rests on several factors:

  • The Chinese stock market has been one of the world’s worst performers in recent years. Since peaking in 2007, it’s down more than two-thirds. Since the S&P 500 bottomed in March 2009, the S&P has returned 141% while the Shanghai Composite Index has fallen 7%.
  • Given that under-performance, it’s unsurprising equity outflows are at multi-year highs. Investors can’t pull their money out of China market fast enough, as the chart below from EPFR shows.

china equity flows

  • Valuations are near decade lows. The Shanghai market is trading at 8x earnings and 1.4x price-to-book. Meanwhile, H-shares (China stocks listed in Hong Kong) are trading at 6x earnings and 1.1x price-to-book. These are 1.3-1.5 standard deviations below their 10-year averages.

HSCEI Price to Book

  • China banks are factoring in a credit crisis. This is important as these banks have the largest weighting in Chinese stock market indices. For instance, they comprise 33% of the H-share index. The prices of these banks imply a non-performing loan ratio (NPL) of 7%, versus the 1% reported and 3.2% provisioned in the third quarter of last year. The 7% implied NPL is at the upper end of historical crisis scenarios globally.

china bank implied NPLs

  • Studies of historical market pullbacks suggest the current correction may be nearing an end.

hscei index level

  • There doesn’t seem to any expectation of positive news on the economic front. Marginally positive news is likely to be greeted well by the market. On this front, I was encouraged by the recent government vow to push ahead with financial liberalisation. A pilot scheme to allow five privately owned banks to be set up in various parts of the country will hopefully inject much-needed competition into the banking sector. Deposit rates will also be liberalised within two years – an overdue move. Such announcements aren’t being given much credit but that could change going forward.

Risks
There are a number of risks buying Chinese stocks. Though these stocks are cheap, they’re not at levels of extreme crises of the past. For instance, the China market bottomed at 5x earnings and 0.4x price-to-book during the Asian crisis. This crisis is an extreme example but there are no guarantees that valuations won’t get to those levels again.

china market corrections

News is expected to deteriorate on the economy. Asia Confidential is looking for property prices to soon roll over. This would have significant ramifications as property is the primary collateral for loans/trading.

If this eventuates, economic data could deteriorate sharply and GDP may head to sub-6% levels. That could hurt sentiment as many investors still don’t expect GDP near mid-single digits.

A credit bust would lead to speculation about whether China may endure a Japan-style prolonged downturn. This seems unlikely.

It’s true that there are a number of similarities between Japan in 1990 and China today. Both countries relied on export-led investment models. When these models faltered, both used credit as a substitute to drive growth. There are many other similarities which are worth studying.

But there are important differences too. In 1990, Japan was a much more developed country than China is today. Japanese GDP per capita was 6x greater. This means that the less developed China has greater scope to grow its way out of debt problems.

In addition, Japan’s stock market and real estate bubbles were arguably much larger than China’s. For instance, Japanese stocks peaked at 70x earnings versus China’s 48x (in 2007).

Lastly, Japan had no track record of changing economic models following crises. China does. The large-scale reforms of the 1970s, 80s and 90s are proof of this.

The final risk to buying China stocks is also related to Japan: that of heightened tensions between China and Japan, perhaps leading to war. This eventuality can’t be ruled out but seems remote given both countries are preoccupied with faltering economies.

What to buy
The focus of any buying of China stocks should be on what I term “new China”. That is, stocks in sectors which should benefit from the country’s switch to a more consumption-driven economy.

Internet stocks should be the first port of call. They have many structural tailwinds. China’s internet penetration rate stands at just 40%, about the level of the US in 2000. Only 25% of households have a personal computer, indicating ample room for growth. Lastly, the smartphone installed base, currently at close to 300 million, is expected to hit 400 million in 2014.

Among the Chinese internet stocks, our current preferences are Sohu, Baidu and NetEase. Sohu operates a search engine called Sogou, in which Tencent recently took a stake. Sogou will be merged with Tencent’s search engine SoSo. This should lead to a significant turnaround in Sohu earnings.

Baidu is China’s Google, operating the country’s largest search engine. It’s in prime position as advertising transitions more to mobile devices.

NetEase produces online games. These games have a huge following. The company has also developed its first mobile game and mobile news dictionary. NetEase is hugely cash generative and around 30% of its market capitalisation is now net-cash. That leaves room for share buybacks and/or increased dividends.

The consumer sector is also one to like. While consumer staples are expensive, retailers aren’t. While the latter faces considerable short-term headwinds, some are priced for it. I like Giordano, a pan-Asian discount retailer with significant exposure to China. It has a great track record and sports a single digit price-to-earnings ratio and sustainable dividend yield of +7%.

Finally, Chinese insurers operate in an under-penetrated industry which should benefit as incomes improve. PICC has a stronghold on property and casualty insurance and is reasonably priced.

AC Speed Read

- Following the recent correction, Chinese stocks offer attractive value.

- The Chinese economy is expected to deteriorate further but that’s largely factored into market valuations, which are near decade lows.

- Our preference is for consumer-related stocks, including internet, retail and insurance plays.

- The primary risk to accumulating Chinese stocks is that valuations could reach more extreme levels if the economic downturn gathers steam.

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What's behind the sudden improvement in US loan growth?

by SoberLook.com

Credit growth in the US seems to have stabilized and may be on the rise. It's worth mentioning that the bottom in loan growth just happened to correspond to the start of Fed's taper. Coincidence?

Total loan growth rate YoY

Whatever the case, this may be a sign of improving demand for credit and banks' willingness to accommodate. The key to this change in trend is that improvements in loan growth have been primarily driven by a sudden jump in corporate lending.

Corporate loan growth rate YoY

Why is corporate America increasing its borrowing all of a sudden? The most likely answer is the improvement in capital expenditures (capex), which is evidenced by firmer capital goods spending by US companies. We saw initial signs of that improvement back in February (see story). There were other indications as well. ISI's latest corporate survey provides further support to this thesis.

ISI Research: - Survey strengthened over the past two weeks with U.S. orders now a solid 61.5. Areas of strength include equipment tied to trucks, rail, aerospace, and construction.
Whether using their massive cash reserves or tapping bank credit facilities (increasing bank loan balances), the time has come for higher capital expenditures by US firms. Here is why.
Barron's: - Capital expenditures [have been] just 46% of operating cash flow for nonfinancial companies in the S&P 500. The average since 1989 is 57%. Capex can't remain low forever. Already, the average age of U.S. structures is the highest it has been since 1964. Equipment hasn't been this old since 1995, and intellectual-property products, like software, since 1983. In a report issued this past week, Bank of America Merrill Lynch predicts U.S. capex growth will more than double over two years, to 5.7% in 2015, from 2.6% last year. Beyond mounting cash and aging plants and equipment, it cites some new factors. Economic growth is picking up, giving business managers more confidence and less spare capacity. Congress even passed a budget this year—one less thing for business leaders to worry about.

Barron's goes on to say that many shareholders are now pushing firms to increase capital expenditures. Much of the capex spending behavior in the post-recession era has been driven by uncertainty. Recently in the US we've had two major sources of such uncertainty: the Fed's taper and the federal government budget/debt ceiling. Both of these macro risks frightened corporate management enough to hold back on capex. The Fed's taper however is now on a slow, fairly predictable "autopilot" and as Barron's points out, the budget deal has removed the risk of a near-term federal impasse. As far as corporate CEO's are concerned, the major uncertainties related to the US federal government have clearly receded - for now.
Thus the similarities in timing of the bottoming of loan growth in the US and the start of Fed's taper may not be a coincidence after all.

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The Fed is Fighting the Wrong Battle Again… And Creating Yet Another Crisis

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A critical element for investors to consider is that the Fed is not forward thinking when it comes to monetary policy. Indeed, if we reflect on the last 15 years, we see that the Fed has been well behind the curve on everything.

First and foremost, recall that Alan Greenspan was concerned about deflation after the Tech Crash (this, in part is why he hired Ben Bernanke, who was considered an expert on the Great Depression).

Bernanke and Greenspan, both fearing deflation (Bernanke’s first speech at the Fed was titled "Deflation: Making Sure It Doesn't Happen Here"), created one of the most extraordinary bouts of IN-flation the US has ever seen.

From 1999 to 2008, oil rose from $10 per barrel to over $140 per barrel. Does deflation look like it was the issue here?

Over the same time period, housing prices staged their biggest bubble in US history, rising over three standard deviations away from their historic relationship to incomes.

Here are food prices during the period in which Greenspan and then Bernanke saw deflation as the biggest threat to the US economy:

The message here is clear, the Greenspan/ Bernanke Fed was so far behind the economic curve, that it created one of the biggest inflationary bubbles in history in its quest to avoid deflation.

Indeed, by the time deflation did hit (in the epic crash of 2007-2008), the Fed was caught totally off guard. During this period, Bernanke repeatedly stating that the subprime bust was contained and that the overall spillage into the economy would be minimal.

Deflation reigned from late 2007 to early 2009 with the Fed effectively powerless to stop it. Then asset prices bottomed in the first half of 2009. From this point onward, generally speaking, prices have risen.

The Fed, however, continued to battle deflation in the post-2009 era, unveiling one extraordinary monetary policy after another. They’ve done this at a period in which stocks and oil have skyrocketed:

Home prices bottomed in 2011 and have since turned up as well (in some areas, prices now exceed their bubble peaks):

Which brings us to today. Inflation is once again rearing its head in the financial system with the cost of living rising swiftly in early 2014.

Rents, home prices, food prices, energy prices, you name it, they’re all rising.

And the Fed is once again behind the curve. Indeed, Janet Yellen and Bill Evans, two prominent members what is now the Yellen Fed (Bernanke stepped down in January), have both recently stated that inflation is too low. They’ve also emphasized that rates need to remain at or near ZERO for at least a year or two more.

Investors should take note of this. The Fed claims to be proactive, but its track record shows it to be way behind the curve with monetary policy for at least two decades. Barring some major development, there is little reason to believe the Yellen Fed will somehow be different (Yellen herself is a huge proponent of QE and the Fed’s other extraordinary monetary measures).

Which means… by the time the Fed moves to quash inflation, the latter will be a much, much bigger problem than it is today.

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Throwing Stones From A Glass House Called Kosovo

by Nebojsa Malic

On Sunday, March 16, two polls will be held in Eastern Europe. One will be   a complete mockery of democracy, resulting in a government determined to trample   a country’s sovereignty and territorial integrity. The other will be a referendum   on independence in the Crimea.

The same powers that launched the illegal,   illegitimate war of aggression against Serbia in 1999, occupied and in 2008   illegally declared a portion of Serbia an independent state, now howl about   “aggression” from Russia and “territorial integrity” of   Ukraine. As Justin Raimondo   puts it, “Western leaders only bloviate about moral and ‘international   law’ when it suits their purposes. Otherwise, when that law is supposed to apply   to them, they shrug it off and suddenly it’s might makes right.” The hypocrisy   ought to be breathtaking, but it’s the normal state of affairs in the West.   “All rights for me, and none for thee” is the sum of the New World    (Dis)Order.

EUtopia

The official Western explanation for the “peaceful protesters” forcing   out an elected government with firebombs and guns is that President Yanukovich   was corrupt, and the “people of Ukraine” wanted a future in the EU,   which is not corrupt   at all. Ahem.

The new government just happens to be headed by the man U.S. Assistant Secretary   of State Victoria Nuland   favored for the post in a conversation leaked in early February. He leads   the party whose name translates as “Fatherland.” Key security   and military positions in the self-proclaimed cabinet are held by brownshirts   from the “Freedom” Party and “Right Sector.” The first thing   the new regime did was abolish the law guaranteeing equal rights to Russian   and other languages in the country. But Washington says they are democratic   democrats, and all this is Russian propaganda. And Washington never lies,   so.

No one has bothered to answer why any Ukrainians would aspire to become vassals   of the EU and live like the Greeks. The EU is advertised as being one great   Germany, but the stark truth is that only Germany is prospering inside the super-state,   while the newer members are seeing their traditional industries smothered by   the ever-rising mountain of impossible regulations.

Also going unmentioned is that becoming like Greece would actually be the end   result of a long, costly and painful process of “reform.” In the   meantime, Ukraine would be more like Serbia, the EU’s current model candidate.

And Serbia is a country that is independent and sovereign only in the very   loosest sense of either word; where no   matter who the people vote for, the government is put together by Brussels   and Washington; and the country is run by what can only be described as a quisling   cult of EU and Empire sympathizers, fanatically devoted to denying and suppressing   all thought there might be an alternative to “Euro-Atlantic integrations.”

On Sunday, March 16, such a Serbia will go to the polls in a command performance   designed to provide a new majority for the ruling Progressive Party, and bestow   legitimacy on the governing coalition’s policies of looting, lawlessness and   treason.

Coup to Con

How did Serbia get to be this way?

What it could not accomplish with bombs in 1999, the Empire did in October   2000 through the prototype “color   revolution“: it toppled a “dictator” in Belgrade who refused   to follow orders, and replaced him with a “democrat” who would. When   he refused to be a puppet, he was politically sidelined in favor of a “pragmatist   go-getter” PM – and when the PM began harboring delusions of independence   and refused to be ordered around by the Imperial ambassador, he   was shot. By early 2004, a suitable sycophant   was installed as president, and in 2008 a coalition   government under his leadership was tortured out of electoral results. Then,   in 2012, a brazen con   job switched out the spent former president and his Democrats for a replacement   quisling and the Progressives. The regime’s policy, however, changed not   a bit – and in fact became more fanatically servile.

Before they were re-branded as “Progressives” by US political consultants,   the current President and “First Deputy Prime Minister” (looking to   drop the “First Deputy” bit next week) of Serbia were the leading   members of the Serbian Radical Party, long demonized as “hardline ultranationalists.”   In the 2012 election, they campaigned on a platform of wanting to engage the   EU and the Empire, but seeking to protect Serbian sovereignty and interests.   Once installed in power, however, the Progs executed a U-turn: Serbian identity,   history and interests were declared “baggage of the past,” and getting   rid of them was necessary for the sake of the bright European future!

The key to this program of identity removal was declaring the NATO rape of   Serbia consensual. Giving up Kosovo, you see, is the key condition for (maybe,   some day, eventually) joining the EU. So a pact   made in Brussels, in April 2013, de facto recognized the statehood   of the occupied province (declared independent in 2008) and disavowed the four   counties still standing for the Serbian constitutional order. This was treason,   yet the West praised   it as statesmanship of the highest order.

The much-ballyhooed “fight against corruption” amounted to overhyped   drug busts and trumped-up charges against one tycoon who conveniently   lacked political protection. The highest court in the country has all but admitted   the April 2013 “Brussels Agreement” is neither legal nor constitutional,   but gave the government “six months to make it work.”

Meanwhile, economic “development” consists of taking out ruinous   loans from the IMF and Arab sheikhdoms, while selling off the country’s assets   as collateral. What isn’t pawned off is looted outright: in just the first decade   following the October 2000 coup, as much as $51 billion has   been siphoned out of Serbia   into various offshore accounts. There is yet no data as to how much the Progs   have contributed to enlarging that sum.

The Actual Kosovo Precedent

Contrary to hysterical pronouncements in the Anglosphere, Russia’s reaction   to the Empire openly meddling on its doorstep has been remarkably restrained.   How would Washington react if a hostile government were installed in Ottawa   by force and fraud? Yet Moscow did not stage a countercoup, or send the tanks   into Kiev. Instead, it moved to secure the Crimean peninsula, which was assigned   to Ukraine by Nikita Krushchev in 1954. Crimea is home to the Russian Black Sea  Fleet, and an overwhelmingly ethnic Russian population.

Imperial propaganda   insists that, unlike the case of Kosovo, the separation of Crimea is absolutely   different and there can be no   comparison. This is a red herring. The only context in which Russia has   mentioned Kosovo is the 2010 decision of the International Court of Justice   on the legality of independence declarations.

As predicted   here at the time, the ICJ’s shameful decision is now coming home to roost.   When Serbia challenged the “Kosovian” declaration of independence,   the Empire strong-armed the ICJ into ruling that it wasn’t illegal per se.   As the dissenting judges pointed out, this involved a “judicial sleight-of-hand”   which redefined the ethnic Albanian provisional legislature – operating under   specific UN rules – as something else. The Crimean legislature is legal, legitimate   and has every right to do whatever it pleases come Monday. And the only “argument”   the Empire can offer in dissent is, “because we say so.” Come to think   of it, that’s precisely all the “argument” it offered in Kosovo.

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