Research Watch

Pimco’s Mohamed El-Erian, the man who famously coined the phrase “New Normal”, now believes the post-crisis period of slow growth and debt problems may finally be coming to an end. Indeed, Deutsche Bank says the deleveraging era is drawing to a close and Jeff Saut thinks we may have entered a new secular bull market without anybody realising. But, Nouriel “Dr Doom” Roubini points out four major risks remain – and GMO has neatly mapped out another: a credit bust in China. Meanwhile, Morgan Stanley is worried the world is insolvent, the OECD and WTO are rewriting global trade data, and you’ll never guess who pooped on the floor at BlackRock’s US headquarters. On video, Warren Buffett on money and happiness.

The ‘New Normal’ could soon be over...

“The ‘new normal’ of slow economic growth, high unemployment and government debt problems could be over soon, according to the man who coined the phrase, Pimco’s Mohamed El-Erian. ‘We said in 2009: three to five years,’ he said, referring to how long he thought the phenomenon would last. In the years since his proclamation, El-Erian said, ‘The ‘new normal’ allowed time for the corporate sector to heal, for the housing sector to heal, and that’s positive. That’s how you come out of it.’  He was not ready to say when the ‘new normal’ would end, but he did lay out what might happen when it does. ‘Everybody wants the positive tale, which is we tip into higher growth, lower unemployment, and we deal with our debt issues through economic growth.’ But, he warned, ‘We have to be careful because of the other tale ... Europe doesn’t get its act together, the Middle East gets more complicated.’  In the near-term, El-Erian stressed the importance for the US government to get its financial house in order. ‘As investors, it’s not just about top-line revenue growth. It’s not just about the economy. It’s also about political risk and policy risk.’“ (CNBC, January 17)

And the age of deleveraging is coming to an end...

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“Assuming perpetual nominal GDP growth of 4.5%, which is only slightly higher than the 4.3% gain registered over the four quarters ending Q3 2012, and assuming steady liabilities, which actually continue to fall modestly, means that household debt to disposable income will be back at long-term equilibrium by Q2 2014.  Of course, nominal GDP growth could turn out to be faster, especially once the budgetary noise from Washington dissipates. A 5% rate of nominal GDP would put us at equilibrium one quarter earlier. … We highly doubt the last one sixth of the deleveraging process by US households will be as painful as the preceding five-sixths of the process, over which time outright debt actually fell. Much of the decline was due to bankruptcies and mortgage foreclosures. Thus, the headwind for further deleveraging should be minimise at this point in the business cycle. … Eventually, we expect households to re-leverage, which would act as a tailwind to economic activity. Conceivably, we could even be in the very early stages of a re-leveraging cycle based on the fact that private consumer credit is no longer falling.” (Joe LaVorgna of Deutsche Bank, January 18)

In fact, we may be entering the next secular bull market...

“The good times could be back for a while and -- dare we say it? -- stocks could be at the start of a secular bull market. The latest optimistic sign came from the Dow Jones Transportation Average, which hit a high last week and is up 7.3% already this year. This implies that some of the most cyclical, economically sensitive stocks -- those of airlines, railroads, and the like -- are having a banner year and don’t anticipate the much-feared recession. Technically, the market enters a bull phase only when the transports and the broader Dow Jones Industrial Average both make new highs. But the DJIA is only 4% away from its all-time record close of 14,164, hit in October 2007. ‘There’s a 25% possibility we’re in a new secular bull market, and no one believes it,’ says Jeffrey Saut, chief investment strategist at Raymond James. Supporting his case: On December 31 and January 2, 90% of stocks traded higher. Such broad-based strength is usually followed by more strength. After two 90%-up days, the market has climbed an additional 6.8% one month later 83% of the time and 12.8% three months later 100% of the time, says Saut.” (Barron’s, January 19)

But don’t forget: risks remain...

“First, America’s mini-deal on taxes has not steered it fully away from the fiscal cliff. Sooner or later, another ugly fight will take place on the debt ceiling, the delayed sequester of spending, and a congressional ‘continuing spending resolution’ (an agreement to allow the government to continue functioning in the absence of an appropriations law). … Second, while the ECB’s actions have reduced tail risks in the Eurozone, the monetary union’s fundamental problems have not been resolved. Together with political uncertainty, they will re-emerge with full force in the second half of the year. … Third, China has had to rely on another round of monetary, fiscal, and credit stimulus to prop up an unbalanced and unsustainable growth model based on excessive exports and fixed investment, high saving, and low consumption. By the second half of the year, the investment bust in real estate, infrastructure, and industrial capacity will accelerate. … Fourth, many emerging markets are now experiencing decelerating growth. Their ‘state capitalism’ – a large role for state-owned companies; an even larger role for state-owned banks; resource nationalism; import-substitution industrialization; and financial protectionism and controls on foreign direct investment – is the heart of the problem. … Finally, … the entire greater Middle East is socially, economically, and politically unstable. … The fear premium in oil markets may significantly rise and increase oil prices by 20%, leading to negative growth effects in the US, Europe, Japan, China, India and all other advanced economies and emerging markets that are net oil importers. While the chance of a perfect storm – with all of these risks materialising in their most virulent form – is low, any one of them alone would be enough to stall the global economy and tip it into recession.” (Nouriel Roubini, January 21)

And China’s financial system could be on the verge of collapse...

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“China’s credit system exhibits a large number of indicators associated with acute financial fragility. These include:

1. Excessive credit growth (combined with an epic real estate boom)
2. Moral hazard (i.e., the very widespread belief that Beijing has underwritten all bank risk)
3. Related-party lending (to local government infrastructure projects)
4. Loan forbearance (aka ‘evergreening’ of local government loans)
5. De facto financial liberalisation (which has accompanied the growth of the shadow banking system)
6. Ponzi finance (i.e., the need for rising asset prices to validate wealth management products and trust loans)
7. An increase in bank off-balance-sheet exposures (masking a rise in leverage)
8. Duration mismatches and roll-over risk (owing to short wealth management product maturities)
9. Contagion risk (posed by credit guarantee networks)
10. Widespread financial fraud and corruption (from fake valuations on collateral to mis-selling of financial products)”

Not only does financial fragility look to be on the rise, Beijing seems to be on the verge of losing control over the credit system. Savings are migrating from deposits in the state-owned banking system to higher-yielding nonbank credit instruments. Furthermore, rich Chinese are increasingly willing to evade capital controls and take their money out of the country. As a result of these developments, deposits in the banking system are becoming less stable. ‘Red Capitalism,’ namely the ability of the Chinese authorities to direct the country’s enormous savings for their own ends, faces an existential threat.” (Edward Chancellor and Mike Monnelly of GMO, January 22)

Is the world insolvent?...

“Morgan Stanley has an interesting research note on the debt crisis arguing that most developed governments are effectively insolvent. It draws up a stylised balance sheet for a government: its assets are the ability to tax (the discounted value of future tax revenues), plus real assets (buildings, equipment), equity stakes and cash. On the liabilities side, there are the market debts (bonds and bills) and the net present value of future ‘primary’ expenditure (items such as pensions and health care). ... The shortfalls are so large (between 800% and 1,000% of GDP in the US and UK) that Morgan Stanley thinks the situation is hopeless. In effect, the public sector must impose a burden on the private sector but the only question is how. Greece has already had to opt for outright default. Those countries that can borrow in their own currencies will opt for financial repression—keeping interest rates negative in real terms. … The implications for investors, says the bank: ‘With fixed income yields at record lows due to financial repression, we prefer equities over bonds. However, with yields likely to stay low for a long time because of repression, we wouldn’t make a major move out of bonds, as significant losses are unlikely.’“ (The Economist, January 16)

Global trade data is being re-written...

“The US trade deficit with China is much smaller than current official data suggest, according to a year-long study that transforms the global picture of trade imbalances between countries. In a joint study, the Organisation for Economic Co-operation and Development and the World Trade Organisation have for the first time highlighted the flaws in labels such as ‘Made in China’ or ‘Made in Germany’, by tracking the origin of components and services rather than final products. The OECD and WTO said their investigation into how goods and services are actually produced highlighted the folly of trade barriers. Angel Gurría, head of the OECD, said: ‘We have to think about goods and services as ‘made in the world’, forcing a radical change in how we need to look at trade flows’.  … According to the joint study, the US trade deficit with China in 2009 was not $176bn but $131bn – or 25% lower – because so much of the value of ‘Chinese’ electronic exports include components sourced from other countries such as South Korea and Japan. The joint study will undermine calls in the US to label China a ‘currency-manipulator. … Mr Gurria indicated that the renminbi’s alleged undervaluation was now a ‘less important and less relevant’ issue, adding that it was ‘senseless’ to focus policy on bilateral trade issues.” (Financial Times, January 16)

As illustrated by Boeing’s 787 Dreamliner...

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“Boeing is one of the most iconic American brands. It’s a symbol of American manufacturing. And orders for Boeing’s aircraft frequently move the monthly US economic data. But most people don’t realise that Boeing’s  aircraft aren’t very ‘Made In The USA’.” (Goldman Sachs via Business Insider, January 15)

Two penguins walk into a boardroom...

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“Yep, that’s a pair of Magellanic penguins, calmly milling around the reception area for Blackstone’s offices in Midtown Manhattan. … The visit was arranged courtesy of staffers from SeaWorld Parks and Entertainment, a Blackstone portfolio company currently in the process of going public, on hand for a presentation at The New York Times Travel Show this week, according to a person with direct knowledge of the matter. … Unfortunately, the pair left some unsolicited presents on a carpet and a conference table — both easily cleaned up.” (Deal Book, January 17)

Video of the Week: At home with Warren Buffett...

(CBS, January 21)