"Ingwa wa, kuruma no wa." (Cause and effect is like a wheel) - Japanese Buddhist Proverb
Japan was once the marvel of the globe. Their efficiency and manufacturing prowess was revered and Japanese companies morphed from obscurity into global power houses. Japanese executives were seen trolling the globe armed with fists full of Yen and the desire to snap up buildings and companies around the globe. The Japanese stock exchange reached an all time high of 38,915 in December of 1989 and it seemed as if the Japanese were invincible.
Fast forward to today and Japan is in a world of hurt. The current administration under Shinzo Abe is fighting deflation and slow growth with.Mr. Abe's economic stimulus plan, Abenomics consisting of three measures: monetary easing, fiscal stimulus and structural reforms. These measures were expected to repair Japan's economy through quantitative easing strategies similar to the United States, spending to stimulate private investment and structural reforms to make the market more open to new businesses and improve labor policies to reduce the reliance on welfare and make the labor market more flexible.
After a year of actively pursuing the first two strategies the results are anything but stellar. The effect of quantitative easing has been to devalue the Yen by more than 25%. While this was the intended effect the results were not as expected as exports have not flourished as they have in the past. Normally when a currency devalues it promotes exports of local products as they become cheaper on the international markets. As Japan relies heavily on exports, devaluing the currency has been a quick fix to stimulate the economy however this time around the effect was muted by the fact that a large majority of exporters are building their products off shore. The result is that Japan government debt has rocketed to more than 220% of GDP and this is creating a new set of problems.
At the present level (and growing) debt service payments are more than 25% of the government's annual budget and this is with interest rates at essentially zero. Even a small rise in interest rates to say 2% would effectively make the government insolvent as the tax receipts would not cover the debt payments. In an effort to stem this tide Japan raised its consumption tax from 5% to 8% in April. The result of this move is that the country's economy declined at an annual rate of 7.1%. While many believe that this trend will reverse in the current quarter there is another round of consumption tax increases expected in October 2015 so it would not surprise me to see consumption stay down for an extended period.
Another side effect of the weakening Yen has been to hike the cost of base goods like electricity. With the loss of a large portion of the country's nuclear power and the aftermath of concern following the Tsunami and the radiation leaks Japan has come to rely more and more on natural gas powered plants. As Japan is not a gas producer this gas is imported but with the price of natural gas tied to the USD the Yen weakness has resulted in a spike in the cost of producing electricity. These price increases are being pushed on to the Japanese consumer who is now paying 28% more for their electricity than they were four years ago. Between this squeeze, consumption tax increases and lackluster pay increases it is no wonder that the consumer is closing their wallets.
So the only arrow left in Abe's quiver is to change the country structurally. The problem with structural reforms is that they do not happen overnight and Japan needs something to happen quickly as time is running out. Amazingly through all of this the Nikkei is leaping to 6 year highs on the back of some stellar company earnings courtesy of the weak Yen but if the structural problems facing Japan are not sorted out these highs may soon be distant memories much like the high last printed 25 years ago. While all of this seems to be unrelated to the United States consumer, one need only look at the issues that arose out of Europe's mess to see that any significant problems in the world's third largest economy would be felt around the globe.
Friday, September 26, 2014
Friday, September 19, 2014
China's Ascendancy
"Open sesame!" - Alibaba and the Forty Thieves
Today marked an historic occasion as Alibaba's stock was listed on the New York stock exchange. It marked the largest IPO ever raising the company more than $21 billion and valuing it at more than $220 billion. The shares opened up more than 40% making Ma, the founder, China's wealthiest man. Talk about "Open Sesame"! To think that he started the company in 1999 in his house while teaching English as a school teacher makes the story even more remarkable and even more like the original story (he was a poor woodcutter who found an entrance to a secret cave where thieves hid their loot; the words Open Sesame unlocked the cave entrance and access to a fortune).
What also interests me is that this Chinese company not only eclipsed the likes of Facebook and Amazon but it shows China;s ascendancy into a technology superpower that more than rivals the United States. Furthermore it shows just how important a large population and rapidly expanding middle class can be to local companies. The company boasts more than 220 million active buyers using its platform and it now has plans to expand its services and platform throughout the rest of the world.
He will now use American money to expand internationally taking on Amazon, EBay, Google and others while these companies face massive government intervention in their efforts to expand throughout China. So the protectionism that China has for its companies has worked in that they are now becoming global players but at what point in the future will the walls blocking free entrance to China be removed so that there can be a level playing?
With the Chinese flag flying in front of the NYSE today it appears that greed trumps everything but to me it also shows that business and economic freedom can supersede political squabbling. It is now time for the Chinese to allow foreign businesses to operate freely throughout China but in order to achieve this we have to turn to the politicians to hash out an agreement. While this will take time and will come with a large amount of baggage and distrust, until things can be ironed out I will continue to marvel at the greed that is American investment banking but hopefully Alibaba can use the magic words to open the gates to free competition.
Today marked an historic occasion as Alibaba's stock was listed on the New York stock exchange. It marked the largest IPO ever raising the company more than $21 billion and valuing it at more than $220 billion. The shares opened up more than 40% making Ma, the founder, China's wealthiest man. Talk about "Open Sesame"! To think that he started the company in 1999 in his house while teaching English as a school teacher makes the story even more remarkable and even more like the original story (he was a poor woodcutter who found an entrance to a secret cave where thieves hid their loot; the words Open Sesame unlocked the cave entrance and access to a fortune).
What also interests me is that this Chinese company not only eclipsed the likes of Facebook and Amazon but it shows China;s ascendancy into a technology superpower that more than rivals the United States. Furthermore it shows just how important a large population and rapidly expanding middle class can be to local companies. The company boasts more than 220 million active buyers using its platform and it now has plans to expand its services and platform throughout the rest of the world.
He will now use American money to expand internationally taking on Amazon, EBay, Google and others while these companies face massive government intervention in their efforts to expand throughout China. So the protectionism that China has for its companies has worked in that they are now becoming global players but at what point in the future will the walls blocking free entrance to China be removed so that there can be a level playing?
With the Chinese flag flying in front of the NYSE today it appears that greed trumps everything but to me it also shows that business and economic freedom can supersede political squabbling. It is now time for the Chinese to allow foreign businesses to operate freely throughout China but in order to achieve this we have to turn to the politicians to hash out an agreement. While this will take time and will come with a large amount of baggage and distrust, until things can be ironed out I will continue to marvel at the greed that is American investment banking but hopefully Alibaba can use the magic words to open the gates to free competition.
Friday, September 12, 2014
And We All Go Down Together
"Money cannot buy you happiness, but it does bring you a more pleasant form of misery." - Spike Milligan
"The only people who buy at the lows and sell at the highs are .... liars." - Baruch
"The investor's chief problem, and even his worst enemy, is likely to be himself." - Benjamin Graham
Part of what I do on a daily basis is trade the futures and commodities markets. While I do not trade in all of them I do trade a wide variety namely crude oil, natural gas, S&P 500 Index, Gold, Silver, Copper, Corn and Soybeans. I do not trade currencies as the government manipulation (and I am not just talking about the US government but all of them) makes it too difficult to predict a trend and for the time being I have stayed out of the financials market. My trading style is agnostic as to the price direction. I am just as willing to short a market as I am to buy it which serves me in good stead regardless of market directions.
The trading philosophy is based on my proprietary algorithm which spits out signals which I use to enter or exit trades. These signals are not influenced by CNBC or any of the other squawk boxes and therefore provides signals that can sometimes seem counter intuitive. Needless to say the system works incredibly well and has provided an excellent rate of return for me over the years. Now the reason I bring all of this up is not to pat myself on the back but to alert you to something very interesting.
Starting at the end of July the price of crude oil began to fall. At the time going short crude oil with all of the world's crises (particularly in Russia and the Middle East) seemed completely the wrong direction but as it was a signal and rule one is to obey all signals, I sold short a position in crude. Right behind that came a short sale in Soybeans followed by Silver and then Gold and then Copper. Furthermore the long position that I had in the S&P 500 was stopped out (meaning that the price fell sufficiently to trigger my sell signal) and since then the market has continued to slid lower along with all of the above commodities.
It is not since 2008 that I have received so many sell signals all at once and while the market is still a while away from another sell signal it certainly seems to be heading lower. One thing to remember is that these trades are normally pretty short term and they can turn in an instant which is why I do not normally post anything about trading but when everything starts to go down together it is a real eye opener and so for this blog I thought I would alert you as to my current findings. Whether this is the beginning of a decent market correction or just another short term trend is unknown but one thing I do know is that until these markets can turn around it is not looking to good for the stock market.
It is also interesting to note that the bond market has also been falling all month. Normally in these types of markets you would see bonds rallying but with the Federal Reserve starting to talk about inflation and possibly raising interest rates even this safe haven is leaking. This rise in interest rates is starting to have a negative impact on the housing market but it is too soon to gauge whether this is a secular move or just a slow down before winter. Only time will tell.
As I mentioned in last week's blog a lot of these moves are being caused by the meteoric rise in the dollar index and while that has taken a breather this week it appears that it has done a lot of damage in a very short time. The export of weakness from Europe, Japan and China is being felt in the United States and we will see if it feeds into the results of the S&P companies but I would imagine that it will in the quarters ahead unless there is a sudden reversal of dollar strength. So at present, unless you are short pretty much everything it certainly appears a time to keep your head down and your eyes on the dollar.
"The only people who buy at the lows and sell at the highs are .... liars." - Baruch
"The investor's chief problem, and even his worst enemy, is likely to be himself." - Benjamin Graham
Part of what I do on a daily basis is trade the futures and commodities markets. While I do not trade in all of them I do trade a wide variety namely crude oil, natural gas, S&P 500 Index, Gold, Silver, Copper, Corn and Soybeans. I do not trade currencies as the government manipulation (and I am not just talking about the US government but all of them) makes it too difficult to predict a trend and for the time being I have stayed out of the financials market. My trading style is agnostic as to the price direction. I am just as willing to short a market as I am to buy it which serves me in good stead regardless of market directions.
The trading philosophy is based on my proprietary algorithm which spits out signals which I use to enter or exit trades. These signals are not influenced by CNBC or any of the other squawk boxes and therefore provides signals that can sometimes seem counter intuitive. Needless to say the system works incredibly well and has provided an excellent rate of return for me over the years. Now the reason I bring all of this up is not to pat myself on the back but to alert you to something very interesting.
Starting at the end of July the price of crude oil began to fall. At the time going short crude oil with all of the world's crises (particularly in Russia and the Middle East) seemed completely the wrong direction but as it was a signal and rule one is to obey all signals, I sold short a position in crude. Right behind that came a short sale in Soybeans followed by Silver and then Gold and then Copper. Furthermore the long position that I had in the S&P 500 was stopped out (meaning that the price fell sufficiently to trigger my sell signal) and since then the market has continued to slid lower along with all of the above commodities.
It is not since 2008 that I have received so many sell signals all at once and while the market is still a while away from another sell signal it certainly seems to be heading lower. One thing to remember is that these trades are normally pretty short term and they can turn in an instant which is why I do not normally post anything about trading but when everything starts to go down together it is a real eye opener and so for this blog I thought I would alert you as to my current findings. Whether this is the beginning of a decent market correction or just another short term trend is unknown but one thing I do know is that until these markets can turn around it is not looking to good for the stock market.
It is also interesting to note that the bond market has also been falling all month. Normally in these types of markets you would see bonds rallying but with the Federal Reserve starting to talk about inflation and possibly raising interest rates even this safe haven is leaking. This rise in interest rates is starting to have a negative impact on the housing market but it is too soon to gauge whether this is a secular move or just a slow down before winter. Only time will tell.
As I mentioned in last week's blog a lot of these moves are being caused by the meteoric rise in the dollar index and while that has taken a breather this week it appears that it has done a lot of damage in a very short time. The export of weakness from Europe, Japan and China is being felt in the United States and we will see if it feeds into the results of the S&P companies but I would imagine that it will in the quarters ahead unless there is a sudden reversal of dollar strength. So at present, unless you are short pretty much everything it certainly appears a time to keep your head down and your eyes on the dollar.
Friday, September 5, 2014
Deflation Rears Its Head
"The catastrophic destruction of wealth that began in January 1990 has left assets, equities and real estate mainly deflated against a mass of liabilities that are mainly bank loans." - Carl B. Weinberg
This week the European Central Bank (ECB) announced that it would aggressively tackle the deflationary problem that is plaguing Europe. As can be seen by the chart below Spain and Greece are already in a deflationary spiral with Italy barely positive. Europe as a whole saw inflation at the lowest level in 5 years with a reading of 0.3% so the ECB cut its Refinancing Rate to 0.05% and its Deposit Rate to -0.2% (that is not a misprint it is a negative interest rate - essentially you are charged for a deposit). They will also begin to purchase Asset Backed Securities at a rate of $14 billion a month in an effort to stave off continued deflation.
So what impact will this have on the rest of the globe and particularly the United States. First off I would be highly surprised to see US interest rates move higher. With the dearth of European capital looking for a home and the United States 10-year Treasury at 2.40% it is the best buy in town. In contrast the yield on the German Bund is 0.96%, Switzerland is 0.48%, France is 1.29%, Spain is 2.13% and Italy is 2.32%. Would you really want to take on the risk of Spanish or Italian debt over the United States? This demand for yield has driven the dollar to 52 week highs. While this strength is inevitable it will cause some issues for US exporters and this should result in a slow down in United States GDP.
Furthermore the rise in the dollar and the deflationary spiral of Europe are weighing on commodities. As most commodities are priced in USD an increase in the value of the dollar means that the price increases in Europe and other countries. Increased prices means less demand and less demand is showing up in the price of Gold, Silver and Oil, all of whom have fallen more than 10% in the last few months. While this will keep the lid on inflationary pressure in the United States there will be some worry that Europe will export deflation and for this reason I find it highly unlikely that the Federal Reserve will raise interest rates any time soon and they may even consider another round of quantitative easing.
The reason for the massive fight against deflation is that economies run on the premise of economic growth and asset appreciation. As the economy grows so the demand for goods and services increases and this results in price inflation and asset appreciation. It also results in greater profits and higher wages and with this comes wealth creation and once again more expansion and inflation and so it goes. Now if you have price contraction or deflation then consumers are not interested in buying goods and services as the price is lower tomorrow. With the reluctance of consumers to buy comes a contraction of GDP and a fall in asset values as the demand wanes. With the value of debt set and the underlying asset value declining the result is another wave of defaults, layoffs and so it goes. Under this deflationary scenario it is extremely difficult to stimulate even using negative interest rates for the simple reason that prices may be falling faster then the negative interest rate plus you can keep you money in cash removing the impact of the negative rate. With asset prices falling investment is shunned so stocks, properties and other hard assets take a beating.
For now this is predominantly a European problem but as you can see it can easily be exported and some of the effects are already showing up in the United States. These initial benefits (lower prices at the gas station and minimal inflation) create a small windfall but if this windfall does not translate into job and economic growth wallets are soon shut. So for now the United States is enjoying the reprieve of price pressure which is allowing the Federal Reserve to stay its course of cutting stimulus without the worry of interest rates rising but unless the ECB can reign in their problems we may soon be receiving another unwanted import.
This week the European Central Bank (ECB) announced that it would aggressively tackle the deflationary problem that is plaguing Europe. As can be seen by the chart below Spain and Greece are already in a deflationary spiral with Italy barely positive. Europe as a whole saw inflation at the lowest level in 5 years with a reading of 0.3% so the ECB cut its Refinancing Rate to 0.05% and its Deposit Rate to -0.2% (that is not a misprint it is a negative interest rate - essentially you are charged for a deposit). They will also begin to purchase Asset Backed Securities at a rate of $14 billion a month in an effort to stave off continued deflation.
So what impact will this have on the rest of the globe and particularly the United States. First off I would be highly surprised to see US interest rates move higher. With the dearth of European capital looking for a home and the United States 10-year Treasury at 2.40% it is the best buy in town. In contrast the yield on the German Bund is 0.96%, Switzerland is 0.48%, France is 1.29%, Spain is 2.13% and Italy is 2.32%. Would you really want to take on the risk of Spanish or Italian debt over the United States? This demand for yield has driven the dollar to 52 week highs. While this strength is inevitable it will cause some issues for US exporters and this should result in a slow down in United States GDP.
Furthermore the rise in the dollar and the deflationary spiral of Europe are weighing on commodities. As most commodities are priced in USD an increase in the value of the dollar means that the price increases in Europe and other countries. Increased prices means less demand and less demand is showing up in the price of Gold, Silver and Oil, all of whom have fallen more than 10% in the last few months. While this will keep the lid on inflationary pressure in the United States there will be some worry that Europe will export deflation and for this reason I find it highly unlikely that the Federal Reserve will raise interest rates any time soon and they may even consider another round of quantitative easing.
The reason for the massive fight against deflation is that economies run on the premise of economic growth and asset appreciation. As the economy grows so the demand for goods and services increases and this results in price inflation and asset appreciation. It also results in greater profits and higher wages and with this comes wealth creation and once again more expansion and inflation and so it goes. Now if you have price contraction or deflation then consumers are not interested in buying goods and services as the price is lower tomorrow. With the reluctance of consumers to buy comes a contraction of GDP and a fall in asset values as the demand wanes. With the value of debt set and the underlying asset value declining the result is another wave of defaults, layoffs and so it goes. Under this deflationary scenario it is extremely difficult to stimulate even using negative interest rates for the simple reason that prices may be falling faster then the negative interest rate plus you can keep you money in cash removing the impact of the negative rate. With asset prices falling investment is shunned so stocks, properties and other hard assets take a beating.
For now this is predominantly a European problem but as you can see it can easily be exported and some of the effects are already showing up in the United States. These initial benefits (lower prices at the gas station and minimal inflation) create a small windfall but if this windfall does not translate into job and economic growth wallets are soon shut. So for now the United States is enjoying the reprieve of price pressure which is allowing the Federal Reserve to stay its course of cutting stimulus without the worry of interest rates rising but unless the ECB can reign in their problems we may soon be receiving another unwanted import.
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