PORTFOLIO POINT: This is a sampling of this week’s best research notes. In a world of too much information, we hope our selection helps you spot the market’s key signals.
China's soft inflation figures were generally welcomed by investors, who saw the data as a sign that Beijing may have more room to loosen policy and stimulate growth. But this week, John Hempton warns that a lower rate of inflation also threatens to unravel a great “Chinese kleptocracy” that maintains domestic stability and also underpins China's massive international bond buying program: “Unless the Chinese can get the inflation rate up, expect a revolution.” The other big story is that Dave Rosenberg, who for years has been one of Research Watch's favourite bears, has surprised clients with the revelation that he expects to enter the “perma-bull” camp as early as November (that's bound to set off some contrarian alarm bells). Perhaps less surprising is John Hussman's latest bold call: the US recession is here “now”. Meanwhile, Nomura has noticed that the euro is trading like an emerging market currency, while the Pakistani rupee is being bought like nothing we've seen before. Find out how to evade national capital controls, how JP Morgan proposes to liquidate itself in case of an emergency, and where you can buy Gianni Versace's former mansion. On video, meet Bill and Patty Sutherland, who turned their retirement into a permanent Tuscan holiday.
The macroeconomics of China's kleptocracy... China's one child policy, which is expected to leave tens of millions of grandparents without a large enough family to support them in retirement, is ultimately driving up the national savings rate and funding a “Chinese kleptocracy,” according to Bronte Capital blogger John Hempton. The Australian money manager argues that China's strict capital controls and “unbelievably corrupt” stock market leave the country's middle class with little option but to store its money in regulated bank accounts with yields as low as 1%. “This is a lousy savings mechanism because inflation has been between 6% and 8%,” he says. “In other words, real returns for bank accounts are consistently negative.” In turn, China's state-controlled banks lend those savings to state-owned enterprises (SOEs) at negative real interest rates, allowing the Party elite to “loot on a scale unprecedented in human history.” He says: “When you have copious funds at a negative cost, a lot of investments that look stupid under some circumstances suddenly look sensible. US Treasuries look just fine. ... The Chinese make a positive arbitrage on holding low-rate US bonds.” While outsiders generally consider inflation to be a destabilising force in China, resulting in a quicker erosion of savings, Hempton says the “Chinese establishment likes inflation – it is what enables their thievery to be financed.” The more serious threat to China is deflation, or even inflation at rates of 1% to 3%. “Low Chinese inflation rates will mean reasonable returns on savings for Chinese lower and middle income savers. Good news for peasants perhaps. But that changing division of the spoils of economic progress will destroy the Chinese establishment (an establishment that relies on a peculiar and arguably unfair division of the spoils).” Essentially, SOEs would no longer generate the positive real returns that fund high-level embezzlement. “Unless the Chinese can get the inflation rate up, expect a revolution.” (Bronte Capital, June 10)
Rosenberg the perma-bull?... “The future is brighter than you think. This does not mean we will not have another recession, by the way ' we had a doozy within the first two years of the fabled Reagan presidency, but we endured nonetheless and came out stronger on the other side once the inflationary excesses of the day were purged (today, it is a case of curing a deflationary debt deleveraging). '¦ What Reagan managed to do was instill confidence with a coherent, credible and cogent strategy that gave people ' who make up the economy ' a higher degree of certainty over the future. I cannot stress how important it is for any government to ensure at all times that households and businesses have as much clarity over the policy outlook as possible. That makes it easier to plan ahead. And in turn, it leads to better economic results. I’m noticing a certain degree of despair these days, just as I am getting enthusiastic about the future. Much depends on what happens on November 6th and between now and then we still have the European mess, China hard landing risks and the US debt ceiling issue to confront. Be that as it may, those with some dry powder on hand will have their clients in a solid position to take advantage of whatever forced 'panic' selling takes place. For the record, I do see a light at the end of the dark tunnel. Don’t be surprised if I end up turning bullish ahead of the pack ' though it may not be until the like of my good friend, Jim Paulsen, is hiding under his desk screaming 'uncle'! But the Rosenberg shift to perma-bull status ' I was there in the 80s and 90s, but obscurity got in the way ' could come as early as Thanksgiving (November 22). '¦ I’m so excited I just can’t hide it. But for now, I’m keeping the powder dry.” (Dave Rosenberg of Gluskin Sheff, June 12)
Welcome back to recession... “By our analysis, the US economy is presently entering a recession. Not next year; not later this year; but now. We expect this to become increasingly evident in the coming months, but through a constant process of denial in which every deterioration is dismissed as transitory, and every positive outlier is celebrated as a resumption of growth. To a large extent, this downturn is a 'boomerang' from the credit crisis we experienced several years ago. The chain of events is as follows: Financial deregulation and monetary negligence -> Housing bubble -> Credit crisis marked by failure to restructure bad debt -> Global recession -> Government deficits in U.S. and globally -> Conflict between single currency and disparate fiscal policies in Europe -> Austerity -> European recession and credit strains -> Global recession. In effect, we’re going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable.” (John Hussman of Hussman Funds, June 11)
Don't buy all the news... “For a sustainable rally we would need the following: either a stabilisation in macro momentum or, more importantly, a robust policy response. Restart of the SMP programme, short selling bans nor the IMF rescue of Spain fit the bill. Markets tended to quickly rollover post these types of actions historically. Eurobonds remain as distant as ever. However, if ESM were to get a banking licence and were to be used for direct peripheral bank recapitalisations, this would be a very important positive. We think the likelihood of this is low at present, but if it were to happen we would have to get more constructive. An aggressive policy response by Chinese and/or US officials could be another positive signal, but this is not likely immediately. In ’08/’09 China delivered fiscal stimulus worth 14% of GDP, compared to nearly nothing now. We would not use the hope of QE3 as an argument to be bullish. If one really thinks QE3 is likely to be announced over the next few months, we believe both the market and macro dataflow would weaken further ahead of this.” (JP Morgan, June 11)
The US decouples from Europe...
“Historically, it has been the pattern for economic weakness and recessions in the United States to trigger economic woes among its trading partners globally; as this chart shows, the U.S. is always just slightly ahead of Europe when it comes to an economic downturn. Now the question becomes whether this pattern will reverse itself: the fear that Europe’s economic woes will come home to roost in the United States sparked what some pundits have dubbed over-reactions in both bond and stock markets during May. True, some economic data has come in slightly weaker than expected, but there are no clear indicators that growth is poised to evaporate. Still, the anxiety is that Europe’s woes are so severe that it is impossible for them not to spread.” (Pragmatic Capitalism, June 13)
The euro becomes an emerging market currency... “We now appear to have entered a third phase of the eurozone crisis, where ... domestic investors are starting to push more money abroad, in a dynamic resembling of what we previously observed around traditional emerging market currency crises. '¦ First, balance of payments data from the ECB showed outsized foreign fixed income buying by eurozone investors in March. '¦ Second, our tracking of weekly mutual funds trends point to '¦ unusually strong buying of foreign fixed income in April, May and June. This is a departure from previous trends, which typically showed repatriation of foreign fixed income assets in bearmarkets for risky assets. Third, over the past two weeks, there has been evidence that both the Swiss and Danish central banks intervened aggressively in May to counter the pressure from strong foreign inflows. Fourth, the idea of capital flight into non-eurozone markets from eurozone investors fits with the price action in global sovereign bond markets. '¦ Nomura say it’s all very indicative of EM-like action. If they are right, the euro will be in for a lot more selling.” (Nomura via FT Alphaville, June 11)
In case of emergency...
(Citigroup via Zero Hedge, June 8)
How to evade capital controls... “1) Buy precious metals and store in a secure jurisdiction. Holding gold and silver overseas is a great way to (a) ensure your savings is protected against inflation, and (b) ensure that your precious metals cannot be confiscated in the event that gold ownership is criminalised in your home country. I strongly recommend Singapore, Hong Kong, and Abu Dhabi as three potential safe jurisdictions for your gold and silver. 2) Open a foreign bank account. For funds that need to be maintained within the financial system (as opposed to precious metals), make sure you have a safe home for your money abroad in a safe, well-capitalized bank. 3) Have a place to go overseas. Economic turmoil brought on by governments stealing people’s savings generally does not bode well for social stability. If things get hairy, you’ll want to have a place to wait it out. And you don’t want to be deciding on the location while you’re packing your bags. '¦ I’ve picked up an 1100-acre farm in central Chile that won’t skip a beat when the financial system implodes. The sovereign debt bubble does not affect whether or not my trees will bear fruit or my vegetables will grow.” (Sovereign Man, June 12)
How much is a one rupee coin worth? '¦ “Up to 2500 rupees if you believe the rumours sweeping Pakistan that the humble coin had inadvertently been made with gold instead of the usual tiny percentage of copper. Shopkeepers across the country have reported being approached by dealers offering vast sums for a coin – with a face value of less than one pence – that inflation has made so worthless as to be frequently tossed aside. '¦ One newspaper claimed a beggar had sold 150 of the coins and bought a motorbike with the proceeds. Other rumours suggested the coins contained uranium and were being smuggled across the border for Iran's secret atomic weapons programme. '¦ Such is the excitement that the central bank has been forced to issue a denial to calm the hysteria and prevent speculators losing their savings.” (The Telegraph, June 12)
The orderly liquidation of JP Morgan... “In March, Gregory Baer, deputy general counsel, presented a plan to policymakers and bankers to show the results of a hypothetical $50bn loss [at JPMorgan]. It showed the bank would fail, shareholders would be wiped out and Jamie Dimon, chief executive, would be fired. '¦ In the doomsday scenario set out by Mr Baer, a $50bn loss would trigger 'a run on the bank' – with $375bn of funding, including bank deposits, draining away. The government would then step in and mark down the bank’s assets, leading to an additional $150bn loss. Shareholders would be wiped out but senior creditors would be transferred to a new bridge company that allows 'critical activities [to] continue to operate smoothly'. Their debt would be restructured into equity. The bank might require $200bn of temporary government funding, though the bridge company would return to the private sector and New JPMorgan would raise $200bn in the private markets to repay the government loan, the plan says.”(Financial Times, June 13)
Could the Brics lose an I?... “Slowing GDP growth and political roadblocks to economic policymaking are just some of the factors pushing up the risk that India could lose its investment-grade rating. '¦ [Standard & Poor's Ratings] states that the Indian government's reaction to potentially slower growth and greater vulnerability to economic shocks could largely determine whether the country can maintain an investment-grade rating or become the first 'fallen angel' among the BRIC nations. The 'BBB-' long-term sovereign credit rating on India is currently one notch above speculative grade.” (Reuters,June 11)
Buy Versace's mansion...
“Casa Casuarina, the ornately decorated South Beach Miami mansion built for the late fashion designer Gianni Versace, has been listed with US$125 million (A$126.5 million) hopes. The iconic Mediterranean-style estate has 10 bedrooms and 11 bathrooms – all Versace’s design – with the style kept by its current vendor, the telecommunications entrepreneur Peter Loftin.” (Property Observer, June 12)
The ultimate commitment to China... “Jim Rogers said ... the US has become world’s biggest debtor nation in history, while China, Japan and South Korea are the major creditor nations. If the renminbi can be exchanged freely in the world, 'I prepare to invest in China for 100 years,' Rodgers added. The smart investor keeps all Chinese shares for his young daughters: nine-year-old Happy Rogers and four-year-old Little Bee, and welcomes Chinese men as his potential sons-in-law. 'He must be very intelligent, older than my daughter, and have had a wide variety of experiences in life, and a great career will be a plus,' he said at the forum. A Chinese student among the audience said he would try his best to meet the demands; the investor immediately gave his business card to the young man.” (Want China Times, June 11)
Video of the Week: Dreams can come true... Ready to embrace their 50 freedoms, Bill and Patty Sutherland sold their house and business and moved to a scenic Tuscan Village.
(AARP, June 1)