Bullish Sentiment on us Equities is at a Recent High…and so is Market Pessimism Regarding the Bullish Sentiment on US Equities.
What a terrible time to invest. We hear it every day: the VIX is at a 2 year low, the put/call ratio is the lowest since January of 2006; US monthly stock market sentiment indices show the ratio of bulls to bears at 2:1, also a two year high; NASDAQ sentiment index is the highest since October of 2007; short interest fell 5.5% on both the NASDAQ and NYSE in December and, finally, the AAII Bull-Bear Spread is around 53%, also a two year high. All this points to investor sentiment at a near-term zenith and if you are a contrarian, as we tend to be, it’s about time to liquidate and run for the hills. The pragmatist in us, however, says hang on, not so fast.
A look at long-term mutual fund cash flows (courtesy of ICI), however, shows the movement back into US equity funds is only just beginning—a proxy for retail investor sentiment. In fact, net outflows from US equity funds stopped and turned positive for the first time only as recently as December 21st—and the net inflow number was tiny, dwarfed by flows into foreign equity funds by some 265:1. That trend continued through year-end with flows into US equity funds positive but tiny in comparison to those into foreign funds. For all the hand-wringing over rising rates, net cash flows into bond funds just went negative during the week of December 8th, continuing until the last week of the year when there was a big reversal, most likely due to asset allocation strategies pegged to the higher interest rate environment engendered by the recent rout in the Treasury market. Meanwhile, the flows out of Muni bonds continues amid fear of defaults by certain states. What to make of this? Well, if sentiment is so high on US equity markets, it has yet to be backed up by the money. And as Jerry Maguire would say…
A day doesn’t go by when we tune into one of the financial channels only to hear a half dozen market experts rehashing our sentiment analysis, using it as evidence that markets are overbought and due for a correction. We don’t necessarily disagree with them except for three important points: first, if everyone is so negative on everyone being so positive, doesn’t that sort of cancel things out? In our humble opinion, the answer is yes. Secondly, and we expect to be laughed at this given our view of technical analysis, the technicians look at all this bullishness with half see it as a good thing, half as bad. Synopses for several technical analyses:
The Pro:
At present, the short-term bullish outlook is supported by a strong technical backdrop, with the SPX advancing above the 1,250 area in mid-December. U.S. equity investors are more bullishly positioned than at any time in the last two years, figures show, following a sharp market rally since September. Investors currently have 10.8 times as many long positions as short positions -- bets on falling prices -- in the United States, the highest since the ratio was calculated two years ago, according to the data. Things that support this positive outlook:
1. Accelerating stock buybacks
2. Accelerating M&A activity
3. An extension of the capital gains and dividend tax cuts originally set to expire in 2011
4. The third year of a presidential term is historically bullish
5. An accommodative Fed
The Con:
We are seeing optimism enter the market recently, which means we may be vulnerable to a short-term pullback. For example:
1. Equity call buying relative to put buying on the Chicago Board Options Exchange and International Securities Exchange is at an extreme.
2. The CBOE Market Volatility Index (VIX) is now trading at a level that is twice SPX historical volatility. During the past two years, when the VIX is trading at such a high premium to SPX historical volatility, a mild to large pullback soon followed. The last time this indicator signaled was early November, ahead of a 3.8% retreat in the SPX.
3. For the first time since late April, domestic stock mutual funds experienced net inflows last week. The inflows are minute relative to the enormous outflows during the past three years, but one has to wonder if this eight-month "extreme" in optimism might precede a pullback in stocks? After all, during the past 10 years, the month of January experienced a correction, or marked the start of a correction, in five of those years (2002, 2003, 2008, 2009 and 2010).
• The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish or neutral on stock market for the next six months. As the masses are usually on the wrong side of market movements, particularly at tops and bottoms, sentiment indicator serve a useful function as contrarian indicators.
• The bullish sentiment (55.9%) and bearish sentiment (18.3%) readings are at fairly extreme levels, as also seen from the bull-bear spread being quite a bit higher than the market peak of October 2007.
• Sentiment indicators are fairly blunt instruments from a timing point of view and can stay at high / low levels for extended periods. However, when companies are overvalued and technical indicators overbought, overbullish sentiment indicators complete a threesome of tools arguing quite strongly for a cautious approach to stock market investment.
Since we don’t cotton well to technical analysis, the fact that their jockey shorts are all in a knot as to how to read the current markets is a good thing to us. When they all agree is when we hit the buy or sell button.
Our third reason to give pause before bracing for the coming sell-off is the ICI data. Yes, money is flowing strongly into equities….but it’s NOT going into US equities! In fact, the recent big flows out of bonds (only after they have sunk in market value by close to 20%) has been redirected into Foreign equity funds. Guess what? India is now down 6% for the year with many of the smaller Asian/Southeast Asian markets dragged lower in tow. So there is definitely some validity to watching the cash flows as an indicator of the retail investor coming in during a market’s last legs. The problem is, it’s not our market they are top-ticking. Predictably, they are chasing the past returns in India and the “Tigers” (or so they used to be called). We like that—because as retail left bond funds after having been burned, so too soon they will leave foreign equity funds after being burned…and where will they have to turn? The US, of course. What else is left? And it will be just in time for all the better economic data, which has been hitting the wires lately.
After a big move on January 2nd, the US markets have tread water, mostly with a downward bias. This is contrary to our, and many other fundamental analysts’ beliefs, that we would see a very strong run through the middle of January followed by a sell-off, which would be a buying opportunity. We’re not sure the sell-off is coming—or if we haven’t already had it (a consolidation as the technicians would say). Perhaps January will be a reverse of what we expect—early weakness followed by a month-end rally. That would sure put a knot in the socks of the fundamental guys as well as the technicians. We’re not saying that there wont be pullbacks, just that it’s too pat to try to call them based on the calendar and that, if they come, they should be short and shallow and present a good buying opportunity. Let’s not forget that the markets are still awash in liquidity and that European weakness/Chinese, Indian Inflation headline risk is not only discounted in investor’s minds but is being addressed in part with China willing to backstop Spain and Japan willing to pitch in to support Portugal. What other headlines do the Euros have to throw at us? And are there not piles of cash lined up for the day when China says “done raising rates?” If this market sells off the catalyst will have to come from within—we’ve heard the China/India/Euro record before.
Wednesday, January 12, 2011
Monday, January 3, 2011
Ramblings of a Portfolio Manager
Santa Claus smiled upon the US equity markets in December, delivering solid gains with much reduced volatility versus prior months. In this market environment, the Kettle Creek fund generated a strong positive return for the month as the high correlations among individual stocks, seen for most of the year, unwound allowing those with stronger intermediate-term fundamentals to outperform.
While 2010 can be characterized as the year investors in the US equity markets spent most of their time looking abroad and worrying, fretting over everything from debt defaults in Europe to inflation in China and military tensions in the Koreas--to name a few--December will be remembered as a welcome respite from global concerns, a month when investors turned their focus to the improved political landscape and strengthening economy at home. It was almost as if investors looked at the troubles overseas and decided, for a month anyhow, to adopt Alfred E. Newman's philosophy of “what, me worry?”
This isn’t to say that there was nothing happening in the global landscape to cause concern to investors at home. Ireland, one of the “I”s in the now infamous PIIGS (the second “I” having been recently added over concerns for Italy), continued to be thrust to the forefront as yet another over-leveraged, slow growth, entitlement-addicted European country in need of a bailout from the IMF and EU while Portugal, the “P,” loomed ever larger on the horizon as the next domino, followed potentially by Spain, the big “S.” China also continued as a global macro concern but for opposite reasons. In an effort to tame inflation in December the PBOC hiked bank reserve requirements for the third time in two months, followed by a Christmas day surprise of a 25 basis point hike in its discount rate. Suddenly, the same investors who have been calling the stated growth rates in Chinese GDP “falsely inflated” began to worry that the PBOC’s attempts to reign in the inflation generated by those “lies” would overshoot, slowing the “engine” of global economic growth too far and thrusting the world back into recession. And even while the mid-term elections in November improved the political backdrop at home, in December we were reminded that the bureaucrats are alive and well in Washington as the SEC launched a massive insider trading probe with some high-profile hedge-fund arrests while their counterparts on the other side of the hill at the newly created Consumer Financial Protection Bureau continued to attempt to weaken domestic financial institutions this time by drastically cutting debit card swipe fees charged by credit card companies.
Still, in December, investors believed that much of these concerns had already been discounted in the equity markets and a few early Christmas presents in their stockings helped them think more positively on
equities. On the European front, the IMF and EU moved much more rapidly than in prior situations to
staunch the bleeding in Ireland. Serious talk of a bailout fund to deal proactively with future crises ensued and China began buying up distressed bonds of many European countries (eschewing our own overpriced debt instruments), emerging as a potential financial backstop in future European debt dilemmas, particularly should Spain look to begin sliding into the same morass. As for China, while inflation fears persisted, a weaker-than expected PMI brought comfort to some that the tapping on the brakes efforts were beginning to work. Here at home our own PMI, Consumer Confidence, Industrial Production and Unemployment Claims numbers all came in better than expected and on the political front the Obama Administration rolled over on the Bush tax cuts, extending them another two years for all income brackets while unexpectedly tacking on a Social Security tax cut for all, an extension of unemployment benefits, more generous estate tax provisions and, best of all, a one-year 2% payroll tax cut with a 100% writeoff on capital investments for business. All of this positive news on the domestic economy caused many economists to lift their GDP forecasts for 2011 through 2012 by 50 to 150 basis points, something the markets had not been expecting.
With little new negative news and a spate of good political and economic data the US equity markets responded positively. The VIX dropped to at 3 year low, while Treasury yields began to climb despite the Fed’s efforts on QE2. The dollar climbed as well as did oil prices on expectations of economic strength. Suddenly, talk of a double-dip recession, rife over the summer, turned to hand-wringing over if the Fed would even complete QE2 and when they would start withdrawing liquidity ala the PBOC. In this market environment the Kettle Creek Small Cap Fund performed well as we have been exposed to the cyclical
sectors of the US equity markets all year long in the belief that the domestic economy would continue to strengthen, despite the turmoil in Europe. While this thesis hurt us during the downdrafts of May and August, when the talks of a European contagion were at their zenith, our discipline to stick with the thesis paid off in December. The strongest performing sectors in the fund were Financials, which were helped by the steepening yield curve, and Industrials and Materials, both of which got a boost from the improving economic data even in the face of a slightly rising dollar. Weaker sectors included Technology, to which we have been reducing our exposure, and Consumer Discretionary, which saw some profit taking after a nice run-up into Christmas.
We haven’t changed our outlook on the US equity markets, which continues to be favorable for 2011 and into 2012. We are a little concerned about the decline in Short Interest along with a recent bump in investor confidence—both signal that much of the good news in the Economy may be already discounted in investors’ minds and stock prices in the near term. We also have our eye on interest rates and energy prices with concern that the recent climb in both might begin to choke our nascent recovery. We expect, however, that the news flow domestically will continue to be positive and, though it will drive Treasury prices even lower thus further raising rates, will produce a net outflow from US bond funds and into US equity funds—something that hasn’t happened for over three years but the beginnings of which are just becoming manifest. That would signify an asset allocation shift among institutions as well as a return of the individual investor to the US equity markets. Given the relative size of the US bond market to the equity markets, such a cash flow reversal can produce sizeable stock price gains over the next several years.
While 2010 can be characterized as the year investors in the US equity markets spent most of their time looking abroad and worrying, fretting over everything from debt defaults in Europe to inflation in China and military tensions in the Koreas--to name a few--December will be remembered as a welcome respite from global concerns, a month when investors turned their focus to the improved political landscape and strengthening economy at home. It was almost as if investors looked at the troubles overseas and decided, for a month anyhow, to adopt Alfred E. Newman's philosophy of “what, me worry?”
This isn’t to say that there was nothing happening in the global landscape to cause concern to investors at home. Ireland, one of the “I”s in the now infamous PIIGS (the second “I” having been recently added over concerns for Italy), continued to be thrust to the forefront as yet another over-leveraged, slow growth, entitlement-addicted European country in need of a bailout from the IMF and EU while Portugal, the “P,” loomed ever larger on the horizon as the next domino, followed potentially by Spain, the big “S.” China also continued as a global macro concern but for opposite reasons. In an effort to tame inflation in December the PBOC hiked bank reserve requirements for the third time in two months, followed by a Christmas day surprise of a 25 basis point hike in its discount rate. Suddenly, the same investors who have been calling the stated growth rates in Chinese GDP “falsely inflated” began to worry that the PBOC’s attempts to reign in the inflation generated by those “lies” would overshoot, slowing the “engine” of global economic growth too far and thrusting the world back into recession. And even while the mid-term elections in November improved the political backdrop at home, in December we were reminded that the bureaucrats are alive and well in Washington as the SEC launched a massive insider trading probe with some high-profile hedge-fund arrests while their counterparts on the other side of the hill at the newly created Consumer Financial Protection Bureau continued to attempt to weaken domestic financial institutions this time by drastically cutting debit card swipe fees charged by credit card companies.
Still, in December, investors believed that much of these concerns had already been discounted in the equity markets and a few early Christmas presents in their stockings helped them think more positively on
equities. On the European front, the IMF and EU moved much more rapidly than in prior situations to
staunch the bleeding in Ireland. Serious talk of a bailout fund to deal proactively with future crises ensued and China began buying up distressed bonds of many European countries (eschewing our own overpriced debt instruments), emerging as a potential financial backstop in future European debt dilemmas, particularly should Spain look to begin sliding into the same morass. As for China, while inflation fears persisted, a weaker-than expected PMI brought comfort to some that the tapping on the brakes efforts were beginning to work. Here at home our own PMI, Consumer Confidence, Industrial Production and Unemployment Claims numbers all came in better than expected and on the political front the Obama Administration rolled over on the Bush tax cuts, extending them another two years for all income brackets while unexpectedly tacking on a Social Security tax cut for all, an extension of unemployment benefits, more generous estate tax provisions and, best of all, a one-year 2% payroll tax cut with a 100% writeoff on capital investments for business. All of this positive news on the domestic economy caused many economists to lift their GDP forecasts for 2011 through 2012 by 50 to 150 basis points, something the markets had not been expecting.
With little new negative news and a spate of good political and economic data the US equity markets responded positively. The VIX dropped to at 3 year low, while Treasury yields began to climb despite the Fed’s efforts on QE2. The dollar climbed as well as did oil prices on expectations of economic strength. Suddenly, talk of a double-dip recession, rife over the summer, turned to hand-wringing over if the Fed would even complete QE2 and when they would start withdrawing liquidity ala the PBOC. In this market environment the Kettle Creek Small Cap Fund performed well as we have been exposed to the cyclical
sectors of the US equity markets all year long in the belief that the domestic economy would continue to strengthen, despite the turmoil in Europe. While this thesis hurt us during the downdrafts of May and August, when the talks of a European contagion were at their zenith, our discipline to stick with the thesis paid off in December. The strongest performing sectors in the fund were Financials, which were helped by the steepening yield curve, and Industrials and Materials, both of which got a boost from the improving economic data even in the face of a slightly rising dollar. Weaker sectors included Technology, to which we have been reducing our exposure, and Consumer Discretionary, which saw some profit taking after a nice run-up into Christmas.
We haven’t changed our outlook on the US equity markets, which continues to be favorable for 2011 and into 2012. We are a little concerned about the decline in Short Interest along with a recent bump in investor confidence—both signal that much of the good news in the Economy may be already discounted in investors’ minds and stock prices in the near term. We also have our eye on interest rates and energy prices with concern that the recent climb in both might begin to choke our nascent recovery. We expect, however, that the news flow domestically will continue to be positive and, though it will drive Treasury prices even lower thus further raising rates, will produce a net outflow from US bond funds and into US equity funds—something that hasn’t happened for over three years but the beginnings of which are just becoming manifest. That would signify an asset allocation shift among institutions as well as a return of the individual investor to the US equity markets. Given the relative size of the US bond market to the equity markets, such a cash flow reversal can produce sizeable stock price gains over the next several years.
Monday, December 20, 2010
Monday, December 13, 2010
Ramblings of a Portfolio Manager
Does Chinese Inflation Matter?
For over a year now we have been hearing in the press that the Chinese economy is in a bubble—that too much stimulus in the form of post-crisis Government-injected liquidity has generated scores of worthless, non-productive infrastructure projects, related speculation on real estate and a resulting runaway inflationary economy. The paradox is that many of those bright economists and money managers repeating this mantra also couch their warnings in “if you can believe the data.”
Are the Chinese, in fact, lying about growth and inflation (i.e. is it really lower than reported figures) or do they really have the makings of an overheated economy. And if their economy is overheating, should the People’s Bank of China be concerned along with, by proxy, the rest of the world? Let’s address the purported lack of candor for a second. The story goes that, though China reports an unemployment rate of just 4%, they are really only counting permanent labor in the big cities, and only short-term contracts in rural areas, and there is a big mismatch between skills needed and those available. Unemployment levels, therefore, are understated. As for GDP, the pundits’ favorite theory is that the Country’s growth is supported only by the sheer volume of money injected by the Central Bank and that it is all being funneled into worthless projects, which will contribute no productivity or return to GDP once completed—i.e. once the gas pedal is released, the car will stop —a Chinese Potemkin Village, to mix metaphors. Along with this axiom comes the assertion that the Chinese are just making up the GDP growth figures—that they are doing so not so much for the world’s benefit but to preserve domestic content. On this score there may be some theoretical basis (although not reality) for such allegations. Many economists believe China needs to sustain nearly an 8% GDP growth to keep full employment in the cities or risk many of the rural peasants who migrated there in search of a better life losing their jobs, thereby promoting internal strife. However, just releasing big numbers does not keep people in jobs. We have yet to see a reverse migration of workers back to the countryside nor have we seen any domestic unrest resulting from economic conditions (and believe us, even the Chinese State couldn’t hide that from the world). Doesn’t sound like overstated employment figures to us. As for the productivity of projects completed or in the works, there may be some truth behind the claims, yet the projects often cited (unoccupied apartment buildings, empty towns) are not necessarily ones that will be worthless in the future (unlike our own bridges to nowhere). They are more like bets on future growth and if the State really can engineer a soft landing to 8-9% annual growth, these projects will doubtless become productive and bear economic fruit in the near future. Finally, as of Friday, the Central Bank lifted bank reserve requirements by 50 basis points, the sixth such hike this year. And that is no lie. Central banks don’t just hike reserve requirements to bolster their own government’s “lies” about economic growth—not even in a well-controlled state like China. So there must be some truth the to GDP numbers we have been seeing.
But if the Chinese aren’t lying about their growth, employment and inflation figures, is there cause for concern? Over the weekend the Central Bank released their inflation data for November. Expectations were for 4.7% although the whisper number was for over 5%. The data came in at 5.1%. After Friday’s hike, the Chinese so-called benchmark interest rate stood at 5.56%. That would leave real interest rates at or near zero—what we are trying to engineer in the US and ordinarily a cause for inflationary concern in an economy already back up on its feet. But are rates really hovering at zero in China? No. A further look at Saturday’s inflation data casts a slightly different picture on the so called “overheated” nature of the Chinese economy. Ex-food, the actual inflation rate was only 1.9%--not far above that of our own lackluster economy. That means fully 63% or more (some peg it as high as 78%) of stated Chinese inflation comes solely from rising food prices, which have jumped 12% this year alone but are expected to moderate over the next twelve months. In the US inflation data is typically presented “ex food and energy” as these inputs tend to be volatile and are not considered “structural” components of a long-term inflation picture—certainly the Federal Reserve wouldn’t consider a domestic rate hike based on inflation data, over half of which was based on these non-structural inputs. Why should it be any different in China? In fact, China managed to produce year-over-year industrial output growth of 13.3%, a true indicator of economic health, with retail sales up 18.7%--important to the government’s effort to boost domestic consumption—all with a “core” rate just slightly higher than ours. Not bad in our opinion. In more fully developed economies, like the US, where there is much less “slack” in capacity utilization, employment or wages, such growth would already be producing significant inflation. In an emerging economy like China’s, where there is such slack, high growth can still occur with modest inflation. This is what we are seeing now.
So, back to the question, what will the Chinese do with their benchmark rate and should we be concerned? Reviewing the components of Chinese inflation, if taming the “stated” inflation rate is the policy goal, raising rates will do little to make a dent. People don’t buy food based on interest rates either here or in China—which is why our Fed tends to factor out that part of our inflation data when considering its next move. And, perhaps, that is why we have seen the PBC wait so long to hike the benchmark rate even in the face of very high stated rates of inflation. However, the Chinese Central Bank has a deeper objective in its rate policy and that is reigning in real estate speculation. There, as it does here, rates do matter and the hope is that the Central Bank wont kill the golden goose while aiming at an entirely different target. Will it do so? As the theory goes, if a bunch of educated PhDs here in the states have difficulty engineering a soft landing in an economy whose metrics are well understood, how can a bunch of ex-communists accomplish that in a wild west version? Well, let’s not forget that for better or worse, most of the economists and analysts manning the PBC were educated in the West—in the finest graduate schools, no less. So what we can expect to see in Chinese economic policy probably wont be much different from what a western Keynesian or monetarist would espouse. That’s not to say they will get it right (as certainly economists here seldom do) but let’s not assume they will just be shooting from the hip either. There are lots of tools to accomplish their objective, short of raising interest rates (as we have seen with the reserve rate hike, for example). In our opinion, there most likely will be rate hikes to come in China but they will be modest, measured and well telegraphed. And the PBC will put forward other programs to slow real estate speculation, as they already have. That’s a page from our own Federal Reserve’s manual, something the Chinese have long studied. And if we are right and food inflation moderates, perhaps the cycle of tightening might be much shorter than most forecasters expect. That would be good news for the world economy and, of course, the world’s equity markets.
For over a year now we have been hearing in the press that the Chinese economy is in a bubble—that too much stimulus in the form of post-crisis Government-injected liquidity has generated scores of worthless, non-productive infrastructure projects, related speculation on real estate and a resulting runaway inflationary economy. The paradox is that many of those bright economists and money managers repeating this mantra also couch their warnings in “if you can believe the data.”
Are the Chinese, in fact, lying about growth and inflation (i.e. is it really lower than reported figures) or do they really have the makings of an overheated economy. And if their economy is overheating, should the People’s Bank of China be concerned along with, by proxy, the rest of the world? Let’s address the purported lack of candor for a second. The story goes that, though China reports an unemployment rate of just 4%, they are really only counting permanent labor in the big cities, and only short-term contracts in rural areas, and there is a big mismatch between skills needed and those available. Unemployment levels, therefore, are understated. As for GDP, the pundits’ favorite theory is that the Country’s growth is supported only by the sheer volume of money injected by the Central Bank and that it is all being funneled into worthless projects, which will contribute no productivity or return to GDP once completed—i.e. once the gas pedal is released, the car will stop —a Chinese Potemkin Village, to mix metaphors. Along with this axiom comes the assertion that the Chinese are just making up the GDP growth figures—that they are doing so not so much for the world’s benefit but to preserve domestic content. On this score there may be some theoretical basis (although not reality) for such allegations. Many economists believe China needs to sustain nearly an 8% GDP growth to keep full employment in the cities or risk many of the rural peasants who migrated there in search of a better life losing their jobs, thereby promoting internal strife. However, just releasing big numbers does not keep people in jobs. We have yet to see a reverse migration of workers back to the countryside nor have we seen any domestic unrest resulting from economic conditions (and believe us, even the Chinese State couldn’t hide that from the world). Doesn’t sound like overstated employment figures to us. As for the productivity of projects completed or in the works, there may be some truth behind the claims, yet the projects often cited (unoccupied apartment buildings, empty towns) are not necessarily ones that will be worthless in the future (unlike our own bridges to nowhere). They are more like bets on future growth and if the State really can engineer a soft landing to 8-9% annual growth, these projects will doubtless become productive and bear economic fruit in the near future. Finally, as of Friday, the Central Bank lifted bank reserve requirements by 50 basis points, the sixth such hike this year. And that is no lie. Central banks don’t just hike reserve requirements to bolster their own government’s “lies” about economic growth—not even in a well-controlled state like China. So there must be some truth the to GDP numbers we have been seeing.
But if the Chinese aren’t lying about their growth, employment and inflation figures, is there cause for concern? Over the weekend the Central Bank released their inflation data for November. Expectations were for 4.7% although the whisper number was for over 5%. The data came in at 5.1%. After Friday’s hike, the Chinese so-called benchmark interest rate stood at 5.56%. That would leave real interest rates at or near zero—what we are trying to engineer in the US and ordinarily a cause for inflationary concern in an economy already back up on its feet. But are rates really hovering at zero in China? No. A further look at Saturday’s inflation data casts a slightly different picture on the so called “overheated” nature of the Chinese economy. Ex-food, the actual inflation rate was only 1.9%--not far above that of our own lackluster economy. That means fully 63% or more (some peg it as high as 78%) of stated Chinese inflation comes solely from rising food prices, which have jumped 12% this year alone but are expected to moderate over the next twelve months. In the US inflation data is typically presented “ex food and energy” as these inputs tend to be volatile and are not considered “structural” components of a long-term inflation picture—certainly the Federal Reserve wouldn’t consider a domestic rate hike based on inflation data, over half of which was based on these non-structural inputs. Why should it be any different in China? In fact, China managed to produce year-over-year industrial output growth of 13.3%, a true indicator of economic health, with retail sales up 18.7%--important to the government’s effort to boost domestic consumption—all with a “core” rate just slightly higher than ours. Not bad in our opinion. In more fully developed economies, like the US, where there is much less “slack” in capacity utilization, employment or wages, such growth would already be producing significant inflation. In an emerging economy like China’s, where there is such slack, high growth can still occur with modest inflation. This is what we are seeing now.
So, back to the question, what will the Chinese do with their benchmark rate and should we be concerned? Reviewing the components of Chinese inflation, if taming the “stated” inflation rate is the policy goal, raising rates will do little to make a dent. People don’t buy food based on interest rates either here or in China—which is why our Fed tends to factor out that part of our inflation data when considering its next move. And, perhaps, that is why we have seen the PBC wait so long to hike the benchmark rate even in the face of very high stated rates of inflation. However, the Chinese Central Bank has a deeper objective in its rate policy and that is reigning in real estate speculation. There, as it does here, rates do matter and the hope is that the Central Bank wont kill the golden goose while aiming at an entirely different target. Will it do so? As the theory goes, if a bunch of educated PhDs here in the states have difficulty engineering a soft landing in an economy whose metrics are well understood, how can a bunch of ex-communists accomplish that in a wild west version? Well, let’s not forget that for better or worse, most of the economists and analysts manning the PBC were educated in the West—in the finest graduate schools, no less. So what we can expect to see in Chinese economic policy probably wont be much different from what a western Keynesian or monetarist would espouse. That’s not to say they will get it right (as certainly economists here seldom do) but let’s not assume they will just be shooting from the hip either. There are lots of tools to accomplish their objective, short of raising interest rates (as we have seen with the reserve rate hike, for example). In our opinion, there most likely will be rate hikes to come in China but they will be modest, measured and well telegraphed. And the PBC will put forward other programs to slow real estate speculation, as they already have. That’s a page from our own Federal Reserve’s manual, something the Chinese have long studied. And if we are right and food inflation moderates, perhaps the cycle of tightening might be much shorter than most forecasters expect. That would be good news for the world economy and, of course, the world’s equity markets.
Tuesday, November 23, 2010
Ramblings of a Portfolio Manager
And They All Said QE2 Would Fail.
In this holiday-shortened week we thought it only appropriate to publish a holiday-shortened Ramblings. With all the crises around the world, why do we eschew addressing the global troubles in depth? Alfred E. Newman comes to mind. “What? Me worry?”
It’s Tuesday. Let us briefly recount the global fears of the week so far: 1. China is going to tighten itself into a recession. 2. Ditto for Hong Kong. 3. Ireland is either going to sink into the Ocean or go to the Greens (why not? it is the Emerald Isle) 4. The rest of the PIGS are going to be taken down by Ireland. 5. The SEC, seeking to burnish its image post Bernie Madoff, is going to destroy the US financial system and 6. Just in, North Korea took a few pot shots at South Korea, causing the Japanese Prime Minister to suggest that war might ensue. Just another week in the richly diverse ecosphere that we call mother Earth (makes you wonder where all those hand-holding, Coke-holding kids singing on the mountain top went). So why are we adopting a c’est la vie attitude toward it all, just two days from Thanksgiving in the US? Exactly.
We’re not big movie buffs but we’ve seen all these titles before—some more times than our kids have watched the Spongebob Movie (ugh). So, let’s close our eyes and describe that film, scene by scene. 1. The pundits tell us that China is either a fraud or a bubble. Get your story straight and we’ll decide whether or not to start worrying. Meanwhile, we’ll take 9+% growth and p/e ratios on their ADRs of 5x or less. 2. What is Hong Kong and why do we care if their property market cools? Do they buy anything from us, or from anyone else for that matter? They’re an exporter—actually, a re-exporter, turning around products from the Mainland and shipping them worldwide. If anything, cheaper land there means more arable property on which to grow bamboo for chop sticks. That sounds good for the US. 3. The IMF and EU have Ireland under control. Yes, we know they are all wine-drinking socialists but they are acting fast (unlike what they did with Greece) and with determination. They have everything at stake to save the EU and the Euro and they will do so or die. 4. We’re tired of hearing about the PIGS. The only thing they all have in common is the aforementioned affinity for wine. Not a recipe for contagion. 5. No-one kicked in our door looking for files yesterday. Goldman will pay another $half billion to the SEC to make things go away. So will dozens of other wealthy hedge funds and, after the obligatory “perp walks” blazoned across the TV screens over the next week or so, we will hear nothing more about this—certainly nothing about what the Treasury will do with all that money it will collect from settlements. 6. South Korea is very, very limited by treaty in the response it can take with the North. Over the years we’ve seen shots fired across the border, ships and subs sunk, missiles fired and countless other antagonistic actions, all without serious repercussion. The reality is that the Russians don’t want them fighting, the Chinese don’t want them fighting and the US doesn’t want them fighting. They will not fight. Besides, battle hardened Hillary is on the case.
We like turkey and we like thanksgiving buffets. Our favorite buffet, at $40/head for kids, $75 for adults, was booked months in advance and is no longer taking wait list candidates. Meanwhile, we can’t get that Lego Harry Potter set for the kids because Amazon is already sold out of the $140 toy. The dumb bunny on CNBC (it’s just too pat that her IQ is double digits and, literally, her last name means rabbit) at 4am just told us that EU Consumer Confidence and PMI both beat expectations and that US retail sales are already coming in stronger than expected. Expectations for Black Friday in the US get ramped up every day. Of course, all that information will probably soon be deemed insider information but, in the meantime, we call it empirical research and it tells us that things just aint so bad, even here.
“Risk on, Risk off” in the markets, says the dumb bunny. We wonder if she understands how hard it is to hedge and unhedge a $5bn portfolio overnight--even with options and ETFs—as if any responsible manager would do that in response to a headline, even if permitted by mandate, after every financial instrument has already reacted accordingly. Meanwhile, amid all this “turmoil” the worry warts and hand wringers will do the “Risk off” trade and sell their stocks and go back into the Dollar and US Treasuries as a safe haven. Heck, they’ll probably buy some really cheap gold while they’re at it. And as they do, Mr. Bernanke will thank them for making his work on QE2 so much easier and potentially more successful and we thank them for another opportunity to get some good multinationals on the cheap. So much to be thankful for. Gobble Gobble.
Happy Thanksgiving!
In this holiday-shortened week we thought it only appropriate to publish a holiday-shortened Ramblings. With all the crises around the world, why do we eschew addressing the global troubles in depth? Alfred E. Newman comes to mind. “What? Me worry?”
It’s Tuesday. Let us briefly recount the global fears of the week so far: 1. China is going to tighten itself into a recession. 2. Ditto for Hong Kong. 3. Ireland is either going to sink into the Ocean or go to the Greens (why not? it is the Emerald Isle) 4. The rest of the PIGS are going to be taken down by Ireland. 5. The SEC, seeking to burnish its image post Bernie Madoff, is going to destroy the US financial system and 6. Just in, North Korea took a few pot shots at South Korea, causing the Japanese Prime Minister to suggest that war might ensue. Just another week in the richly diverse ecosphere that we call mother Earth (makes you wonder where all those hand-holding, Coke-holding kids singing on the mountain top went). So why are we adopting a c’est la vie attitude toward it all, just two days from Thanksgiving in the US? Exactly.
We’re not big movie buffs but we’ve seen all these titles before—some more times than our kids have watched the Spongebob Movie (ugh). So, let’s close our eyes and describe that film, scene by scene. 1. The pundits tell us that China is either a fraud or a bubble. Get your story straight and we’ll decide whether or not to start worrying. Meanwhile, we’ll take 9+% growth and p/e ratios on their ADRs of 5x or less. 2. What is Hong Kong and why do we care if their property market cools? Do they buy anything from us, or from anyone else for that matter? They’re an exporter—actually, a re-exporter, turning around products from the Mainland and shipping them worldwide. If anything, cheaper land there means more arable property on which to grow bamboo for chop sticks. That sounds good for the US. 3. The IMF and EU have Ireland under control. Yes, we know they are all wine-drinking socialists but they are acting fast (unlike what they did with Greece) and with determination. They have everything at stake to save the EU and the Euro and they will do so or die. 4. We’re tired of hearing about the PIGS. The only thing they all have in common is the aforementioned affinity for wine. Not a recipe for contagion. 5. No-one kicked in our door looking for files yesterday. Goldman will pay another $half billion to the SEC to make things go away. So will dozens of other wealthy hedge funds and, after the obligatory “perp walks” blazoned across the TV screens over the next week or so, we will hear nothing more about this—certainly nothing about what the Treasury will do with all that money it will collect from settlements. 6. South Korea is very, very limited by treaty in the response it can take with the North. Over the years we’ve seen shots fired across the border, ships and subs sunk, missiles fired and countless other antagonistic actions, all without serious repercussion. The reality is that the Russians don’t want them fighting, the Chinese don’t want them fighting and the US doesn’t want them fighting. They will not fight. Besides, battle hardened Hillary is on the case.
We like turkey and we like thanksgiving buffets. Our favorite buffet, at $40/head for kids, $75 for adults, was booked months in advance and is no longer taking wait list candidates. Meanwhile, we can’t get that Lego Harry Potter set for the kids because Amazon is already sold out of the $140 toy. The dumb bunny on CNBC (it’s just too pat that her IQ is double digits and, literally, her last name means rabbit) at 4am just told us that EU Consumer Confidence and PMI both beat expectations and that US retail sales are already coming in stronger than expected. Expectations for Black Friday in the US get ramped up every day. Of course, all that information will probably soon be deemed insider information but, in the meantime, we call it empirical research and it tells us that things just aint so bad, even here.
“Risk on, Risk off” in the markets, says the dumb bunny. We wonder if she understands how hard it is to hedge and unhedge a $5bn portfolio overnight--even with options and ETFs—as if any responsible manager would do that in response to a headline, even if permitted by mandate, after every financial instrument has already reacted accordingly. Meanwhile, amid all this “turmoil” the worry warts and hand wringers will do the “Risk off” trade and sell their stocks and go back into the Dollar and US Treasuries as a safe haven. Heck, they’ll probably buy some really cheap gold while they’re at it. And as they do, Mr. Bernanke will thank them for making his work on QE2 so much easier and potentially more successful and we thank them for another opportunity to get some good multinationals on the cheap. So much to be thankful for. Gobble Gobble.
Happy Thanksgiving!
Wednesday, November 17, 2010
Ramblings of a Portfolio Manager
News Flash: Lincoln Shot. South May Rise Again. Hide in Your Root Cellar and Don’t Forget Your Musket
It has always amused us that, while we operate in a stock market deemed highly efficient by the economists and other smarter-than-us PhD types, the same news tends to discounted once, twice, even three times chronologically though the contents and substance of that news package never changes. Take for example a negative preannouncement by a company—Management typically lays out a narrow EPS and revenue range expected to be reported for the quarter gone by, gives full reason for the miss and often gives a narrow projection for the next quarter and the rest of the year. And Wall Street, ever the immediate discounting mechanism (some might say spoiled child not getting its way) will send the stock post-haste to the nether worlds of price and valuation. But that price reaction doesn’t provide a great bargain hunting opportunity for value investors—for, 9 times out of ten (our back of the envelope observation), when that same company reports the exact same news on the originally planned reporting date, the geniuses in portfolio management will engender the same reaction for the same reason. And, God forbid, the company tapes the call and offers it up to those missing the original, we can fully expect the markets to put the stock in the penalty box yet again until the tape is pulled from the web. So much for the Efficient Market Theory.
But that’s all anecdotal evidence (although we are doing some home work on this phenomenon) on individual company reports. What has really gotten our goat (literally) is the markets’ reaction to the “same old same old” vis-à-vis European debt crisis—i.e the PIGS. Personally, we thought we had slaughtered those pigs months ago. Remember when the dollar was to reach parity with the Euro back in May? It was all due to weakness in the PIGS. Remember when commodities and exporters were crushed because a stronger dollar would hurt their sales and earnings? That was the talk back in May. Remember when a weakened Europe would engender a double-dip here in the US? That was back in May as well. Let’s examine that happened and rate the economists’ dire predictions: First, the Euro, instead of hitting parity versus the dollar, climbed steadily to nearly 1,50/1,00 (we intentionally used commas to look cool and Euro). US multinationals, instead of reporting weaker international sales, consistently beat estimates solely bases on European strength and are on fire. Greece, whom Long Island can kick in a rumble, seem settled; Portugal and Spain, larger than Greece but still a speck on the screen, were tamed and sent away with strong assurances. All markets moved up as a result. Meanwhile, ever looking back into the rear view mirror, the Fed decided to launch QE2 in response as an insurance policy, a move which initially sent the US markets into a roil because it was interpreted at the Fed knowing something negative about domestic economic weakness that the rest of us mere mortals did not. In short, none of the dire consequence have occurred and, in fact, things have gotten much, much better on both sides of the shore since May. Yup, the economists got it wrong again. Surprised?
So, here we are again, markets in turmoil, dollar rising versus the Euro, commodities and multi-nationals in the shit can and a host of pundits thinking maybe a double dip might be back n the front burner. The amusingly hypocritical part of it all is that many of those pundits, who at first lauded QE2, then begged for it, are now on the lecture tour panning the whole idea because it could cause—heavens to Betsy—inflation! All based on a few stronger than expected reports from the US economy. What, exactly did those pundits think was the intent of the program? Funny case is that Greece is somehow back in the mix (they are fixing their problem but not as fast as the Austrians or Greenwhich PMs would like). All that’s missing is the goat negotiating the riots. Perhaps Greece would like to lend the goat to the French—they could use a little humor in their seemingly constant parade of protests (we lost count of the myriad reasons years ago--we did too). The goat may also make them feel better about their personal hygiene.
Oh, we forgot China. Things seem to be so strong there economically that they continue to put the brakes on their own economy, hoping to stave off inflation. One pundit we haven’t heard from is Jim Chanos of Kynikos. Smart guy but it was is contention at the beginning of the year that China was in a bubble but at the same time was intentionally over-forecasting its economic strength? Huh? For his sake we hope he covered his shorts before the recent meteoric rise in the Shanghai index.
The Dow, S&P, NASDAQ and Russell have all lost 5+% plus in the last week or so. Partially on the back of Europe, partially due to China and a fair amount based on post-election blues. Is this the correction/pullback/consolidation that the technicians have been calling for? Notice that, long absent from the Tube, they are now back on again, all with a universal call for a drop of anywhere from 3% (done) to 50% (uh huh). Our answer, or question rather, is “what has changed in the global macroeconomic environment since April.” In fact, things have gotten better economically in the world with many of the global imbalances beginning to self correct (no disrespects to the central banks).
Michael Steinhart was on CNBC yesterday calling this price action temporary and based on information already discounted by the market. We tend to agree. Though he is light years smarter than we, we both look at the market from a bottoms up perspective—that is, companies and markets first, then look at what’s going on the world and how it may affect those companies.
And for all those wringing their hands about pending inflation, if you really believe your own PR, sell you Treasuries before you become a casualty. And remember that inflation is good for commodities. The Fed has gone from savior to villain based on your naive concept of what causes inflation (its employment costs, not interest rates per se). So when we reach full employment and the S&P is 500 points higher as a result, look at your depleted bond fund and remember that you were warned.
It has always amused us that, while we operate in a stock market deemed highly efficient by the economists and other smarter-than-us PhD types, the same news tends to discounted once, twice, even three times chronologically though the contents and substance of that news package never changes. Take for example a negative preannouncement by a company—Management typically lays out a narrow EPS and revenue range expected to be reported for the quarter gone by, gives full reason for the miss and often gives a narrow projection for the next quarter and the rest of the year. And Wall Street, ever the immediate discounting mechanism (some might say spoiled child not getting its way) will send the stock post-haste to the nether worlds of price and valuation. But that price reaction doesn’t provide a great bargain hunting opportunity for value investors—for, 9 times out of ten (our back of the envelope observation), when that same company reports the exact same news on the originally planned reporting date, the geniuses in portfolio management will engender the same reaction for the same reason. And, God forbid, the company tapes the call and offers it up to those missing the original, we can fully expect the markets to put the stock in the penalty box yet again until the tape is pulled from the web. So much for the Efficient Market Theory.
But that’s all anecdotal evidence (although we are doing some home work on this phenomenon) on individual company reports. What has really gotten our goat (literally) is the markets’ reaction to the “same old same old” vis-à-vis European debt crisis—i.e the PIGS. Personally, we thought we had slaughtered those pigs months ago. Remember when the dollar was to reach parity with the Euro back in May? It was all due to weakness in the PIGS. Remember when commodities and exporters were crushed because a stronger dollar would hurt their sales and earnings? That was the talk back in May. Remember when a weakened Europe would engender a double-dip here in the US? That was back in May as well. Let’s examine that happened and rate the economists’ dire predictions: First, the Euro, instead of hitting parity versus the dollar, climbed steadily to nearly 1,50/1,00 (we intentionally used commas to look cool and Euro). US multinationals, instead of reporting weaker international sales, consistently beat estimates solely bases on European strength and are on fire. Greece, whom Long Island can kick in a rumble, seem settled; Portugal and Spain, larger than Greece but still a speck on the screen, were tamed and sent away with strong assurances. All markets moved up as a result. Meanwhile, ever looking back into the rear view mirror, the Fed decided to launch QE2 in response as an insurance policy, a move which initially sent the US markets into a roil because it was interpreted at the Fed knowing something negative about domestic economic weakness that the rest of us mere mortals did not. In short, none of the dire consequence have occurred and, in fact, things have gotten much, much better on both sides of the shore since May. Yup, the economists got it wrong again. Surprised?
So, here we are again, markets in turmoil, dollar rising versus the Euro, commodities and multi-nationals in the shit can and a host of pundits thinking maybe a double dip might be back n the front burner. The amusingly hypocritical part of it all is that many of those pundits, who at first lauded QE2, then begged for it, are now on the lecture tour panning the whole idea because it could cause—heavens to Betsy—inflation! All based on a few stronger than expected reports from the US economy. What, exactly did those pundits think was the intent of the program? Funny case is that Greece is somehow back in the mix (they are fixing their problem but not as fast as the Austrians or Greenwhich PMs would like). All that’s missing is the goat negotiating the riots. Perhaps Greece would like to lend the goat to the French—they could use a little humor in their seemingly constant parade of protests (we lost count of the myriad reasons years ago--we did too). The goat may also make them feel better about their personal hygiene.
Oh, we forgot China. Things seem to be so strong there economically that they continue to put the brakes on their own economy, hoping to stave off inflation. One pundit we haven’t heard from is Jim Chanos of Kynikos. Smart guy but it was is contention at the beginning of the year that China was in a bubble but at the same time was intentionally over-forecasting its economic strength? Huh? For his sake we hope he covered his shorts before the recent meteoric rise in the Shanghai index.
The Dow, S&P, NASDAQ and Russell have all lost 5+% plus in the last week or so. Partially on the back of Europe, partially due to China and a fair amount based on post-election blues. Is this the correction/pullback/consolidation that the technicians have been calling for? Notice that, long absent from the Tube, they are now back on again, all with a universal call for a drop of anywhere from 3% (done) to 50% (uh huh). Our answer, or question rather, is “what has changed in the global macroeconomic environment since April.” In fact, things have gotten better economically in the world with many of the global imbalances beginning to self correct (no disrespects to the central banks).
Michael Steinhart was on CNBC yesterday calling this price action temporary and based on information already discounted by the market. We tend to agree. Though he is light years smarter than we, we both look at the market from a bottoms up perspective—that is, companies and markets first, then look at what’s going on the world and how it may affect those companies.
And for all those wringing their hands about pending inflation, if you really believe your own PR, sell you Treasuries before you become a casualty. And remember that inflation is good for commodities. The Fed has gone from savior to villain based on your naive concept of what causes inflation (its employment costs, not interest rates per se). So when we reach full employment and the S&P is 500 points higher as a result, look at your depleted bond fund and remember that you were warned.
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