Random Shots

Watching, monitoring, and analysing the economy and her markets is as much about tracking discourses (and how they change) as it is about perusing data material on various leading and lagging indicators. And thus, as I am still knee deep into putting the last touch on my thesis [1] I thought that I might as well move in with some random shots at what just might (or might not) be a subtle change of discourse in the context of the areas of the economy I am interested in.


Rallying Risky Assets no More?

The first interesting piece that got my attention was the coverage by FT Alphaville's Tracy Alloway of this week's musings by JPMorgan and UBS about whether the recent dip in risky assets (and subsequent rally of the buck) is a decisive turning point or merely a blip à la Dubai.

In terms of a change in discourse there is not much in the way of one as e.g. JPMorgan's equity team concludes;

We advise adding to positions on weakness and would revisit this view if jobless claims were to move back towards 500k, if Greek default becomes a reality or if manufacturing leading indicators roll over.

Now, this appears as full out frontal bid on equities to me since if jobless claims were to move into the 500ks it would not, I presume, happen overnight as well as a de-facto Greek default would constitute, an ex-post, post mortem on an equity market in shambles as it would surely wreck havoc even in the initial stages. As for the leading indicators they are of course, by nature leading and thus this may be the figue leave JPMorgan can cling on to if and when they decide to back pedal on this bullish strategy. More generally, UBS is quoted of pointing to three sources for the recent dip in risky assets and thus immediate source of a sudden correction. The first is the growing worry by part of Chinese policy makers of the bubblicious state of the economy and thus the incipient signs of monetary tightening. The second relates to the recent barrage from Obama against the financial sector and especially, I assume, the declared war against proprietary trading which has been the source of fat profits for the likes of Goldman, illuminati, Sach, Morgan Stanley and other of their ilk. Finally, there is of course the growing unease in the market place with the unfolding mess in the Eurozone where Greece is still taking center stage teetering on the brink of a bailout in the form of either and IMF led representation or an internal agreement with the EU.

While I certainly agree that those factors represent sand in the otherwise smoothly running machine of excess liquidity driving the rally in risky assets I tend towards a more straightforward source of a potential correction. Consequently, and for all the stimulus and inventory driven growth we are currently observing I think that final demand at the end consumer as well as the willingness and capabilities of companies to ramp up investment will disappoint thoroughly to the downside. The need to rebuild balance sheets and deleverage across all sectors of the real economy will trump the current positive discourse. It is ironic in this sense that the current flurry on government deficits (especially in the Eurozone) represents exactly the inflection point reached by many OECD governments with respect to the need to decisively rein deficit spending in order to put in a reasonable effort at covering future age related liabilities (as the principal although not only reason). In short; it is really difficult to see from which sector in the real economy we are likely to see a recovery to confound the current expectations in the market.

Yet, as is clear from the latest equity research from the good equity analysts at JPMorgan and UBS the discourse is still fixed on recovery. My bet though is that it will change at some point in 2010 in line with the lack of response from the real economy in taking over from stimulus driven growth, but of course; when it comes to the movements of stocks ... I am not the right one to as. Really, I am not! 


Speaking Truth on Japan

Meanwhile in Japan it was interesting to note the comments by economist at the BOJ Kazuo Momma who managed to pinpoint with surgical precision what exactly Japan's current woes are in terms of macroeconomic dynamics;

(Quote Bloomberg)

Japan’s economy is far from achieving self-sustained growth as the export-led recovery fails to spur spending at home, according to Kazuo Momma, the Bank of Japan’s top economist. “The risk that the Japanese economy will fall off from a cliff is small, but there is still a long way to go,” before the expansion becomes sustainable, Momma said in Tokyo today. “Even if the global economy continues to recover, the spread of that to capital spending and the labor market will be limited.”

The key thing to notice above and beyond the real economic effects in the form of entrenched deflation and low growth is the failure of the momentum from external demand to reach the domestic economy. Perhaps more than anything this is the defining characteristic of the Japanese economy and, I would argue, export dependent economies in general. Consider also that the discourse on Japan to large extent has been solidly anchored in the expectation that  the strong momentum of the export related activities would eventually lead into a positive feedback loop with domestic activity. This has so far closely resembled the well known perennial wait à la Beckett and it is worth I think to ask what exactly underlies this disconnect in the economy. In this sense, I thought it interesting that Mr. Momma and thus the BOJ moved in with such a decisive recognition that something seems thoroughly broken in terms of the ability of the domestic Japanese economy to gain traction. 

Elsewhere on Japan I also took note of the veritable tableau d'horreur in the context of the estimated fiscal outlay in the coming years. Consequently, recent numbers from the ministry of finance suggest that Japan will up the its bond issuance by as much as 16% moving towards 2013. Concretely, the butcher's bill is estimated to total 51.3 trillion yen in the year starting April 2011, 52.2 trillion yen in the fiscal year of 2012 and 55.3 trillion yen in the fiscal year of 2013. Naturally, former minister and now opposition member Yoshimasa Hayashi was quick to slam on the critique simply noting that it was unclear whether the new DPJ led government was worried at all about the fiscal conditions of Japan's economy. Specifically Mr. Hayashi worries about 10 year yields which I reckon is the right time horizon for when this could really turn out sour for Japan; (quote Bloomberg) ... 

The deteriorating fiscal position has raised concern that bond investors may start to demand higher yields for holding Japan’s debt. The yield on the 10-year government bond rose half a basis point to 1.31 percent at 2:28 p.m. in Tokyo. It hasn’t exceeded 2 percent in more than a decade.

Finance Minister Naoto Kan said yesterday that the government’s mid-term fiscal strategy to be released by June will help to maintain investors’ confidence. “We need to keep yields around the current level by maintaining markets’ trust in our fiscal health,” he told parliament. S&P’s downgrade of the outlook for Japan’s debt to “negative” indicates it may cut the local-currency rating for the first time since 2002. National Strategy Minister Yoshito Sengoku called the warning a “wake-up call.”

Before we start comparing Japan with Greece et al though there is little doubt that demand will be there for the securities since we can be pretty sure that the BOJ will be provide the bid through quantitative easing. However, in a longer term perspective and with largest debt to GDP ratio as well as the oldest population in the world one does not have to be a macroeconomic literate to see how this cannot go on forever. However, as long as Japan remains a net external lender the problem is one of accounting really and with its own independent central bank the show can go on for quite a while. Moreover, the likely side effect on the JPY makes it an almost attractive route to follow by Japan in the sense that a long waited depreciation of the JPY (if it comes) will not only strengthen the export sector but also provide some welcome inflation to the economy.


Wither the Euro (as a "reserve" currency)?

Perhaps the most interesting headline coming in on the wires in the beginning of the week was this Bloomberg piece running under the header that the Euro is losing its allure as a reserve asset.

Investors are pulling cash out of Europe at a record pace as central banks slow euro purchases, jeopardizing its status as a substitute to the dollar as the world’s reserve currency.

Last year, policy makers loaded up on euros, while analysts at Barclays Plc in London and Aletti Gestielle SGR SpA in Milan predicted central bankers would make good on threats to reduce the greenback’s dominance. Now the euro is down 8.4 percent since Nov. 25 in its fastest slide in 10 months amid concern that cash-strapped countries like Greece won’t pay their debts. Billionaire investor George Soros said Jan. 28 that there’s “no attractive alternative” to the dollar.

Well well, what a difference a couple of jitters in Southern Europe makes. Now, before we get ahead of ourselves in terms of the long term significance of the Euro's recent slip I think this abrupt change in discourse on the Euro is a good testament to the difficulty many have in understanding exactly what these so-called global imbalances are. This may sound arrogant as I imply here that I do actually understand, but I find it extremely difficult to see how people who hitherto believed in the Euro as a the new dominant global currency can suddenly shift position on the back of trouble in Greece, Spain et al. I mean, surely and if you had cared to look and listen the structural difficulties of the Eurozone and the obvious inability of the EUR/USD to move about in the 1.50s/1.60s and thus act as the main vessel of rebalancing were there for anyone to see. Well not quite and while the coup de grace from George Soros is significant in itself I think it worthwhile to think back to the heaty days when Bernanke lowered rates as an initial response to the subprime fallout (and the ECB momentarily raised) and thus where the Eurozone was hailed as the new engine of the global economy to take over from an ailing US economy. Some of us tried to dimiss this nonsense but it appears that it takes near default along the periphery, before it really hit the main wires. So let me be quite clear here. The Euro is not an alternative to the Dollar in so far as goes rebalancing of the global economy which would entail the Eurozone being a relatively large and sustained net external borrower. In fact, given the troubles in Spain and Greece the real challenge is how the Eurozone can become a net surplus region and thus reduce the borrowing of key member countries.


Bubble Trouble in China

This one is hardly news and neither has there been much of a change in discourse as it has been some weeks now that Chinese authorities little by little have started to voice concerns over the growing tendencies of overheating in the Chinese economy and property sector in particular.

China’s “real worry” is asset bubbles as capital flows into an economy awash with money and the nation emerges from the crisis into a “boom time,” central bank adviser Fan Gang said. Moves by the central bank this year to curb liquidity were “timely and necessary,” Fan told a forum in Beijing today. “Although globally we’re still talking about the crisis, China and some developing countries now are facing another boom time.”

Stocks fell in Asia and Europe today on speculation that Chinese policy makers will do more to cool the world’s fastest- growing major economy after two reports showed a sustained rebound in manufacturing and rising prices. Excess liquidity is a “problem” as low interest rates and slower growth in the U.S. and Europe encourage money to flow into China, said Fan, the academic member of the monetary policy committee.

One economist and long time China observer, Andy Xie, that I tend to lean on is much more out spoken on the current risks in China as well as a recent report by BNP Paribas sees  decisive turning point already in 2010 as tighter liquidity conditions begin to bite;

China’s property market “bubble” is set to burst as the government curbs credit growth and clamps down on speculation, according to independent economist Andy Xie As bank lending slows, “it’s very difficult to see this demand continuing,” Xie, formerly Morgan Stanley’s chief Asian economist, told Bloomberg Television in Hong Kong today. Tougher property policies may lower 2010 sales volumes 10 percent, compared with an earlier forecast for growth of as much as 5 percent, BNP Paribas said in a report today.

I agree in the main. The key however is timing and just how far China may run here. It may be longer than many imagine, but I agree with the fundamentals of the argument. Xie apparently thinks that 2010 will see a significant correction. I have no reason to disagree, but a bubble in China (in general) may run a long time before she runs out of steam. Having said this though, recent bits and pieces of information that I have been fed from the ground in China by my "contacts" strongly suggest that a breaking point is near. One key ingredient here according to a property insider in China is that almost all of the stimulus money currently being poured into the Chinese economy (which is a lot) is going into property and needless to say, this cannot run forever.

More generally, a full blow out of the Chinese property sector in e.g. some of the most bubbilicious parts of the real estate sector would constitute a severe dent in the expectations of a global recovery driven from Asia. Perhaps this more than anything suggests why it is important to keep a weary eye on port side property in Shanghai and elsewhere even if you are not in the market for a condo.


A Change in Discourse?

Whether there has really been a change in discourse in some parts of the market as per reference to the points mentioned above or whether I am just preying on a well worn narrative to take some random shots I will leave it for the reader to decide. In general, the ball is still rolling on the recovery discourse but with events in the Eurozone and a Chinese economy looking set to fall short of the promises to pull forward the global economy things might change sooner rather than later. To this I would add the fundamental and lingering trend of deleveraging in all real sectors of the economy which ultimately means that self sustained growth will disappoint thoroughly to the downside and this I hold to be quite certain and not just a random shot.


[1] - Which I will present here in due course.