Thursday, 30 December 2010

Grantham, Yacktman Stick With Big Stocks After 2010 Disappoints

Grantham, Yacktman Stick With Big Stocks After 2010 Disappoints

Friday, 8 October 2010

Currency war

FT reported that the IMF is worried about exchange rate manipulation by some countries:

Governments are risking a currency war if they try to use exchange rates to solve domestic problems, the head of the International Monetary Fund, Dominique Strauss-Kahn, has warned.

“There is clearly the idea beginning to circulate that currencies can be used as a policy weapon,” Mr Strauss-Kahn told the Financial Times on Monday.“Translated into action, such an idea would represent a very serious risk to the global recovery . . . Any such approach would have a negative and very damaging longer-run impact.”

Government bonds, stocks and gold prices all rose on the expectation that central banks of the world’s biggest economies would embark on a round of quantitative easing.

Market View Doesn't Matter

Larry Swedroe: Market View Doesn't Matter

Thursday, 23 September 2010

Greenberg: Can an ETF Collapse? - CNBC

The question of whether an ETF can collapse is the focus of a fascinating new report by Bogan Associates, an under-the-radar investment firm in Boston.
The concern of the Bogan report, as well as other market participants I’ve been talking to, is that the complexity of exchange-traded funds and their increased use as trading vehicles by hedge funds can be quietly but quickly creating serious market risk.

Greenberg: Can an ETF Collapse? - CNBC

Majority Of Money Managers See Market As Undervalued

Majority Of Money Managers See Market As Undervalued

Rethinking The Quarterly Client Meeting

Rethinking The Quarterly Client Meeting

Monday, 20 September 2010

How Expense Ratios and Star Ratings Predict Success

How Expense Ratios and Star Ratings Predict Success

How Expense Ratios and Star Ratings Predict Success

How Expense Ratios and Star Ratings Predict Success

Waka Waka, Its time for Africa

Excerpts from an article written by Larry Seruma, CIO of Nile Capital Management, LLC, titled: A Time to Invest in Africa:

For the past two decades, investors around the world have been riveted on the emerging markets of the four high growth BRICs – Brazil, Russia, India and China. However, as these opportunities fade, other high-growth emerging and frontier markets should become attractive and worthy of consideration to be added to an investor’s asset allocation strategy. Several of these markets are located in Africa, the world’s second largest continent by population and land mass, behind only Asia in both measures. With a population of more than one billion spread among 53 nations and almost 12 million square miles, Africa is becoming too big for investors to ignore. Yet, its financial markets and expanding public companies remain shrouded in mystery for most foreigners.

● A ground floor opportunity with potential for high returns - Already we have seen the first wave of strong returns from Africa. The continent’s economic growth is just forming what we believe is a powerful upward curve that will continue for decades and may produce results as rewarding as the BRICs over time.

● Political risks have been exaggerated - The stereotype of an African country ruled by one-party or military dictators is outdated and exaggerated. More than 90% of African nations now have functioning democracies.

● Strong economic and market growth - Nine of the 15 countries with the highest 5 year growth rate are in Africa and the continent is urbanizing at a faster rate than India and is already as nearly urbanized as China.


● Increased global demand for commodities - Africa holds an estimated 30% of the world’s mineral reserves. A supply that simply cannot be ignored. As BRIC countries industrialize, their demand for natural resources will keep increasing and they are turning to Africa as a source of scarce natural resources - especially energy and industrial metals. If you believe in the commodity growth story over the next five (5) years, Africa will be a prime beneficiary of that growth.

● Low correlation to domestic, international and Emerging Markets - Africa has correlations of 0.59 to S&P, 0.66 to MSCI EAFE, and 0.60 to MSCI Emerging Markets. This fact can have dramatic effects within a well positioned portfolio.

● The China Factor- China has increased its trade with Africa from $10 billion to $90 billion over the past decade. China is committed to investing its growing reserves into real assets around the globe and specifically commodities to secure its future economic growth. Africa as the mineral reserves and should benefit.
●Steadily increasing capital flows - Capital flows to Africa now exceed those of three (3) of the four (4) BRIC countries.

Wednesday, 1 September 2010

Once in a lifetime...

Bill Miller, legendary market-beating fund manager, chairman and chief investment officer at Legg Mason Capital Management, recently commented in the Financial Times that US large-cap stocks offer fantastic buying opportunities, in his view the best in many decades! While one can debate whether this is true or not true, one thing is certain: One should take serious note whenever Bill Miller is talking about investments...

The common view seems to be that the weak stock market reflects a weakening economy.
But we think the converse is more likely: the weak stock market is causing the economy to weaken. It is not a surprise that the recent US consumer confidence numbers were so poor; with the stock market having fallen so sharply since late April, they could hardly be otherwise.
Using the outlook for the economy to predict the direction of the stock market, which most appear to do, is to look at things the wrong way round. The stock market’s behaviour will predict the economy’s future behaviour. The market’s decline since late April foreshadowed the soft economic numbers now being reported, just as the market’s rally beginning in the spring of 2009 foretold the beginning of the recovery now under way.
Markets are all about expectations and the critical question for investors is always, what is discounted? Are the expectations reflected in market prices too high, or too low? One clue is to look at financial stocks. Financials tend to lead the market, both on the upside and the downside.
They have been market leaders off the bottom in March 2009, and they peaked in 2007 well before the market. They peaked about two weeks before the market in April and have led it down in this correction.
If financials begin to act better, the market should follow; and if they languish, then the market is likely to do no better. Financials in particular and the market in general, have been plagued with a variety of worries since April, when concerns about the Greek financial situation led to a more generalised worry about sovereign debt. The BP oil spill, Goldman Sachs coming under fire from the Securities and Exchange Commission, gold’s relentless rise, the shape of the financial reform bill, the spectre of higher taxes as the Bush tax cuts expire, all weighed on the market during this swoon.
To say that they caused the market drop, though, is a stretch. “What will the stock market do, Mr Morgan?” someone asked JPMorgan over a hundred years ago. “Fluctuate,” he is said to have replied. That’s what markets do, and in late April after eight straight weeks higher, the string was broken. The news is always a mix of positive and negative. When markets decline, people point to the negative news; and when it increases, the positive news is emphasised.
This decline has led to elevated levels of bearish sentiment, and bearish activities, such as rising put call ratios, which is probably setting the stage for a rally. I hope so. But hope is not a strategy, as the saying goes.
Having a long-term strategy may seem quaint in a market dominated by high frequency trading, the 24-hour news cycle, the ubiquitous and shrill blogosphere, flash crashes, and where it is repeated as if divinely given that buy and hold is dead.
The summer of 2010, though, when most global markets are down, pessimism about the future is high, and macro concerns predominate, is one of those rare periods where one can reliably adopt a long-term strategy that promises (but of course cannot guarantee) returns superior to what just about everybody else is now doing.
The public’s distaste for equities is palpable and understandable. Negative returns for 10 years in stocks while “riskless” Treasuries have soared, and right after one of the best six months Treasuries have had in the decade, is more than enough to convince folks that stocks are not good long-term investments.
More than 20 years of superior returns over stocks in an asset guaranteed by the US government seems to be sufficient to drive a stake through the heart of the idea that you want stocks for the long term.

It’s a truism in capital markets that the best investments are those that have previously done worst, where expectations are low, demand is down, and prospects appear at best highly uncertain. In 1980, bonds had been through a 30-year bear market relative to stocks, inflation was soaring, yields were at historic highs, yet expected to go higher, and a long bull market in bonds was at hand.
The idea that US interest rates would be near all-time lows 30 years later would have been dismissed as ludicrous. The situation is now reversed, with stocks having underperformed bonds for decades.
The point here is simple: US large capitalisation stocks represent a once-in-a- lifetime opportunity in my opinion to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951. I was one year old then, but did not have sufficient sentience to invest. I do now, and if you are reading this, so do you.

Everything is not hunky-dory...

RGE Monitor's Wednesday Note examines the current state of economic affairs in America. Here are some excerpts from their article:
Growth in Q2 2010 registered a very weak 1.6%, revised down from an original estimate of 2.4%—a sharp slowdown from the 3.7% of Q1. This implies much weaker growth in H1 than even bearish forecasters had expected. Moreover, most of the growth was driven by a temporary inventory adjustment; final sales grew a mediocre 1.1% in Q1 and 1.0% in Q2.

All the tailwinds of H1 will become headwinds in H2. As state and local governments keep retrenching and even the federal stimulus diminishes, the fiscal stimulus will turn into a fiscal drag that will be much more pronounced in 2011 and after some of the 2001-03 tax cuts expire. The base effects from the lousy economic activity figures of 2009 are gone, temporary census hiring is finished and tax incentives—cash for clunkers, the investment tax credit, the first-time homebuyer tax credit and cash for green appliances—have all expired after “stealing” demand and growth from the future.
Personal consumption—70% of aggregate demand—seems off to a rocky start this quarter: Core retail sales for July showed the third decline in the last four months. With inventory restocking over, the investment outlook is equally bleak. Corporate sector capital expenditure, the only component of aggregate demand that grew robustly in H1, appears set to slow: The shipments and new orders indicators of the July durable goods report showed a decline across categories.
Meanwhile, despite the return to marginally positive growth in Q2, investment in non-residential structures will remain anemic at best through H2, given the record-high vacancy rates in commercial real estate. The housing sector is already in a double dip: Single-family starts fell by 4.2% m/m in July, the third consecutive month of decline, and both existing and new home sales touched their all-time lows.
In summary, every component of aggregate demand—with the exception of net exports, which weighed on growth in Q2—appears set to offer a worse contribution to growth in Q3 than the previous quarter.

The truth is that we have not had much of a recovery in the first place, which might prevent the economy from falling enough to display what many would label a double dip—although we are now assigning a 40% probability to such an outcome.
The anemic recovery and downward trend of inflation and inflation expectations are raising concerns that the economy could not only surprise to the downside but eventually stall. A growth rate of 1% or lower (now likely for H2 2010) is a severe growth recession, as potential growth is closer to 3%.
With growth nearly stalled, an unstable disequilibrium arises that is likely to tip the economy into a double-dip recession. The unemployment rate climbs, the budget deficit widens because of automatic stabilizers, home prices keep falling, bank losses are much larger and protectionist pressures come to a boil. Stock markets could sharply correct, and credit and interbank spreads could widen as risk aversion increases.
A negative feedback loop between the real economy and the financial system could easily tip the economy into a formal double dip: The real economy reaches a near-stall speed and risky asset prices correct downward, leading to a negative wealth effect, a higher cost of capital and reduced business, consumer and investor confidence.
Given political and fiscal constraints and banks' unwillingness to lend, we remain doubtful of the potential for policy to prevent a double dip. The real issue facing the U.S. is the need for balance sheet deleveraging and repair, and that will be a multi-year process. The U.S. must brace itself for a long period of below-potential growth.

Wednesday, 18 August 2010

The role of luck...

Forbes.com - Magazine Article

Mutual fund advertisements are far too effective. Fund companies often promote actively managed funds that have generated high returns, and investors flock to such funds. Unfortunately for these investors, there is little relationship between high past returns and high future returns.
Why doesn't strong past performance continue? The primary reason is that luck is a major factor in fund returns, and luck generally does not persist. Investors tend to overlook the role of luck in fund returns. There are thousands of actively managed equity funds, so even if all fund managers were randomly picking their portfolios by throwing darts at a stock page, a large number of funds would still soundly beat market averages.
In a new study finance professors Eugene Fama of the University of Chicago Booth School of Business and Kenneth French at Dartmouth's Tuck School of Business quantify the role of luck in fund returns. They find that the strong returns of actively managed funds are almost always due to luck, not the stock-picking skill of fund managers. The study will be published in the Journal of Finance.

Wednesday, 21 July 2010

Will gold continue to glitter?

While RGE Monitor appreciates that gold was the best asset class during the past decade or so, it is by no means certain it will continue to outperform:

For the better part of 10 years running, all that glitters has, in fact, been gold. Since 2001, the precious metal has outperformed all of the core asset classes, gaining an average 15.3% per year in dollar terms since January 2001.
Gold is back in vogue for several reasons. Investors view it as an alternative to fiat money, as a hedge against extreme economic risks—which now include both high inflation and deflation—and as a measure of protection against financial meltdown. Given the intensity of the economic storm that has broken out over the past three years, in which all three fears have been invoked, gold and its fellow precious metals have spiked in price.
The concerns propelling the price of gold specifically are very real and should not be ignored. But is now the time for investors to jump the gold bandwagon? We wouldn’t encourage it.
Why aren’t we giddy about gold? In short, our core economic forecast scenario does not entail any of the extreme events that could result in a major gold price spike—and given the fact that the metal has already surged in price, we see several potential downside risks. In the abstract, gold is most attractive as a hedge in one of three extreme scenarios: high inflation, persistent deflation, or when the risk of global financial meltdown is large.
We think high inflation in the near-term is unlikely, given lingering slack in advanced economies. For prices to rise, there must be buyers, and weak employment in the U.S. and Europe, coupled with murky economic prospects, has led consumers to retrench and tighten their purse-strings. Should inflation eventually surface, it will do so only after balance sheets have been repaired. Unsterilized Fed intervention will have long since eased, and the Fed will be managing the money supply with respect to a rising money multiplier or by selling assets.
In other words, an increasing money supply is not de facto currency debasement. The demand for money also matters. Deflation risk remains, but Ben Bernanke has signaled in the past that the U.S. could pull out all stops—by printing more money—to prevent this dangerous outcome from materializing. For now, the U.S. dollar remains the preeminent safe-haven in times of severe stress—and a dip toward inflation would happen in such a time—so very much in line with Bernanke’s comments, the U.S. appears to have policy options at its disposal to stave off a period of sustained deflation.
Our core scenario is thus that once national balance sheets are repaired through a protracted and gradual deleveraging of household and public sectors (following the relatively rapid deleveraging of the financial sector, particularly in the United States), excessive deflation and inflation fears will subside. In periods when the risk of global financial meltdown rises, the dollar exchange rate may appreciate against other currencies, but there also tends to be a flight to safety and gold prices appreciate even more. Gold prices tend to rise during periods of financial stress, up until the peak of market concerns—and then fall when the stress is resolved via bailouts or measures that restore market confidence. There are certainly financial storm clouds to worry about—not least because of sovereign debt concerns in the Eurozone. Given this, we think it is possible that gold could continue to trend upward for a period.
We still are not recommending it, however, due to what we see as significant downside risks. They include: the possibility that the dollar-funded carry trade could unravel, popping asset prices—including that of gold—that have been bolstered by cheap borrowing in dollars; the concern that central banks will end quantitative easing and raise interest rates, again decreasing demand for risky investments like gold; and most basically the fear that gold prices have been driven up by herding behavior that could quickly turn the other way, prompting swift losses. Similarly, even as gold spot prices rise due to demand for physical gold in times of severe financial distress, futures contracts and ETFs—the tools many investors now use to invest in gold—could suffer due to increased fears of counterparty risk. Investors should thus take note—while gold and financialized gold products have posted consistent returns over the past decade, there are no guarantees that this golden goose will continue to lay eggs.

Double dip looks doubly certain Outside the Box - MarketWatch

Double dip looks doubly certain Outside the Box - MarketWatch

Wednesday, 14 July 2010

Despite money fears, few hire a financial adviser - MarketWatch

Despite money fears, few hire a financial adviser - MarketWatch

Market gain suggests rally has legs Mark Hulbert - MarketWatch

Market gain suggests rally has legs Mark Hulbert - MarketWatch

Keeping the momentum of successfully hosting the World Cup

Alec Russell, author of ‘After Mandela: The battle for the soul of South Africa’ opined in the Financial Times that some major reforms are necessary to change the outlook for the South African economy:

With its economy accounting for 27 per cent of sub-Saharan Africa’s gross domestic product, South Africa rightly aspires to be the continent’s hegemon. Yet when analysts speculate about the hot emerging markets of the future they tend first to mention Nigeria, with its 170m people. It is not just that the commodity-dependent South African economy is one-dimensional. It also lacks Nigeria’s entrepreneurial dynamism. Partly this is the fault of apartheid which kept most business in white hands. But the ANC retains an apartheid-era distrust of the private sector.
The last is all the more striking as neighbours to the north race to attract business. One lawyer remarked recently how much easier it had been to complete an electricity deal in Mozambique than with South Africa’s cloying state power company. Some economists even argue provocatively that the country risks lagging behind rather than leading the region. Sub-Saharan economies are expected to grow by more than 5 per cent next year. South Africa has struggled to cross that magic mark, which would enable it to reduce unemployment.
Finance minister Pravin Gordhan has kept the left in check on macroeconomic policy. Trevor Manuel, his prudent predecessor, works into the night planning how to refashion the economy. But Africa requires more of the ANC. It has to jettison the tatty remnants of its nationalist mindset – a shift undertaken in Mozambique, Zambia and elsewhere – and refuse to settle for the country’s spluttering trajectory.

Tuesday, 13 July 2010

Hot hands...

FT Newsmine reported last week that even the top fund managers found it very difficult in recent months not to accumulate huge losses:

"John Paulson – one of the world’s most prominent hedge fund managers – has suffered a second consecutive month of steep losses for his flagship hedge funds, most of which are heavily geared towards a recovery in the US economy. Amid volatile stock markets, the $3bn Paulson & Co Recovery fund, which has large positions in US banks such as Citigroup and Bank of America, lost 12.39 per cent in June, according to an investor in the fund.""The loss comes on top of a 9 per cent loss sustained in May when markets were convulsed by a series of shocks including the eurozone sovereign debt crisis and the so-called 'flash crash' in US equity indices. The recovery fund is still up on the year, however, after strong performance in the first quarter.""The $9bn flagship Paulson & Co Advantage fund lost 4.4 per cent in June, and is down 5.8 per cent in the year to date. Mr Paulson’s Credit Opportunities fund – which delivered 340 per cent returns in 2007 thanks to huge short positions against subprime mortgage instruments – was meanwhile down 0.9 per cent in June. Mr Paulson’s gold fund – set up barely a year ago – returned 7.3 per cent last month, however, and is up 13 per cent this year."

Friday, 2 July 2010

Sophisticated investors beware of sophisticated products!

One of the major investment fallacies around is that some investors believe or being told that because they are "sophisticated" they need sophisticated investments which will yield higher returns than those available to ordinary souls. Fortunately, for us -the ordinary investors - this is far removed from reality. Mark T. Hebner, President, Index Funds Advisors, explains this in his weekly column:

In the recent controversy swirling around Goldman Sachs, we have had the good fortune to be introduced to many charming Wall Street expressions such as "ripping the client's face off" or "blowing up the client". However, one term that has kept showing up like a bad penny (or a defaulted subprime mortgage) is "sophisticated investors". Specifically, Goldman has countered the SEC's charges of fraud with the claim that all the poor saps on the wrong side of the synthetic CDO trade were among the world's most sophisticated investors, and thus deserve neither sympathy nor recompense. The merits of Goldman's arguments will be left to the courts to decide. Our purpose here is to take a deeper look into the general application of the term "sophisticated investor".
It is IFA's position that the term "sophisticated investor" carries no value and is best expunged from our vocabulary. There are good investors who diversify both within and among asset classes, control their costs, and keep constant vigilance over their self-destructive behavioral tendencies. Investors who fail to do these things can be classified as poor investors (pardon the double entendre). It has nothing to do with one's level of investable assets. While it may be tempting to apply the "sophisticated investor" label to certain institutions such as Goldman Sachs which had not a single day of trading losses in the first quarter of 2010, we would be remiss not to point out that the bulk of these trading profits derived from their ability to borrow from the government (i.e., taxpayers) at zero and collect a spread on lending back to Uncle Sam, all the while using leverage to magnify their gains.
Regarding Goldman's "recommended top trades for 2010" for its ultra-sophisticated clients, a recent article on Bloomberg.com showed that seven of the nine trades have been money losers so far in 2010. Some of the trades, such as buying the Polish Zloty while shorting the Japanese Yen almost sound a bit goofy. The spokeswoman for Goldman Sachs, Gia Moron (You can't make this stuff up!), declined to comment. Considering that the clients of Goldman Sachs are receiving investment ideas from a firm that does not owe them a fiduciary duty the term "sophisticated" seems highly misappropriated.
When we hear that someone is labeled as a "sophisticated investor", two possible images come to mind. The first one is of the high net worth individual who has access to exotic investments that are off limits to the most investors. Chief among these would be hedge funds. It is important to bear in mind that hedge funds are not required to report their performance, so the overall performance of various hedge fund categories reported by various databases is likely to be heavily upward biased. If you are a client of a major Wall Street firm and your broker tells you that you are a sophisticated (or qualified) investor, IFA's best advice is to turn around and run for the hills. This term is often used as a license to sell you a complex product with high fees and hidden risks such as leverage. The application of these terms to investors has often led to a dilution of fiduciary duty, which even if it is not explicitly contractual, is normally expected by clients. Just as Goldman and the other Wall Street sharpies regarded their trading partners (e.g., AIG) as sheep waiting to be slaughtered, clients of these firms have no reason to expect better treatment.
The second image of the sophisticated investor is the rocket scientist from MIT employed at Goldman Sachs who designs exotic derivative instruments that the rest of us can barely begin to comprehend. As with the wealthy hedge fund investor, risk and return are inseparable, and no application of brainpower will ever result in cheating risk. The market owes nobody a higher return merely because they are smarter than most of its participants. Every mathematical model in finance is built on assumptions, and 2008 taught us what happens when one of these assumptions turns out to be incorrect.
Other strategies that we associate with sophisticated investors are short-selling and buying on margin. However, thanks to companies like Profunds and Direxion, anybody, regardless of their level of "sophistication", can take a double/triple leveraged/short position in almost every index under the sun. A question worth asking is whether having access to these strategies is more likely to enhance or destroy wealth. The fact of the matter is that even if someone can successfully predict the return of an index over the next 1 to 12 months (which nobody can do except by luck alone), he will not be able to capitalize on his investment acumen using these instruments.
When it comes to sophisticated investors, it is truly a case of the emperor having no clothes, so perhaps the world would be a better place if we limited our use of the word "sophisticated" to describe advanced tastes such as art, music, or literature.

Wednesday, 23 June 2010

A flexible yuan

RGE Monitor states their opinion and expectations on the latest announcement by the Chinese ahead of the G20 summit to allow greater flexibility in the exchange rate of their currency:

Our general takeaway is that the increase in flexibility could help China manage price pressures and asset markets better, but any moves are likely to be gradual. It seems likely that the approach of the G20 meetings had something to do with Beijing’s timing—and some analysts have called it a clever stroke that is likely to shift attention away from China and toward the U.S. as delegates at the summit discuss global economic imbalances.
We expect China to allow a modest and nominal appreciation against the USD of no more than 4% on an annual basis in the next year. Yet even though we expect gradualism and caution from the PBoC, we expect global markets—and particularly risk assets and proxies for China revaluation, especially in Emerging Market Asia—to react positively to the move in the short-term.
A change away from the almost-two-year-old U.S. dollar peg, implemented in mid-2008 as the U.S. financial crisis intensified and the dollar fell sharply, was widely expected as part of China’s exit strategy from crisis management. However, many market participants expected that the euro’s sharp fall against the dollar would delay a Chinese revaluation at least until July. The specifics remain uncertain, but the PBoC seems likely to return to the multi-currency basket, within a band, with a crawling peg regime of the type that prevailed from mid-2005 to mid-08 (the composition of the basket is undisclosed).
Aside from political pressures ahead of the G20 summit, the regime change may be interpreted as a way to address the urgent need to stoke domestic demand in surplus countries (including China). This shift will be necessary in order to rebalance and sustain global growth, given that deficit countries are retrenching.
The longer-term effect could well be a paradoxical eventual depreciation against the USD, which would help offset the competitiveness losses from the recent sharp fall in the EUR. After all, the eurozone (EZ) is China's largest export destination. Greater flexibility of China’s exchange rate is necessary for Chinese and global adjustment. An economy growing as fast as China’s needs tighter monetary conditions than a sluggish U.S. economy which continues to need monetary stimulus. Importing U.S. monetary policy limits the tools China has to promote domestic demand, forcing it to rely instead on financial repression to channel funds to increase production and reduce inflationary pressures.
Chinese private consumption has continued to pick up, but allowing the RMB and thus Chinese purchasing power to appreciate is a pre-condition for Chinese and global growth. Macro-prudential regulations, including a shift away from policy based loans and a gradual increase in interest rates to reduce the transfers of Chinese household savings to corporations are even more important.
A sharp appreciation against the euro and dollar, without other policies to support Chinese consumption, could contribute to much slower global growth and higher inflation as higher Chinese production costs are transmitted to G10 consumers. China’s labor costs have already resumed the gradual upward grind that began in 2007 and 2008; demographics, labor unrest and militancy (strikes) and policies to develop rural areas suggest that they will continue to climb. This world could be one in which countries compete for a shrinking market share, putting risky assets under more pressure.

Monday, 14 June 2010

The evils of a strong currency

Herman Van Rompuy, president of the European Union, blamed in an interview with the Financial Times the strength of the euro in recent years for blinding the eurozone to its underlying fiscal problems.
“What went wrong wasn’t what happened this year. What went wrong was what happened in the first 11 years of the euro’s history. In some ways we were victims of our success.
“The euro became a strong currency with very small interest rate spreads [on government bonds]. It was like some kind of sleeping pill, some kind of drug. We weren’t aware of the underlying problems.”
Mr Van Rompuy said that the 16-nation bloc had been on the edge of a breakdown last month that could have caused a world crisis. But European leaders now understood that the way forward was to implement politically unpopular but necessary economic reforms, such as opening up labour markets and raising the retirement age.

Mr Van Rompuy acknowledged that the markets had played a useful role since the Greek debt crisis erupted last October in identifying weaknesses in eurozone economic governance. But he fully supported tougher financial market regulation, especially for credit rating agencies and derivatives markets – measures EU authorities are drawing up.

“Most of us are not happy with excessive market developments. But when you look at this in a broader perspective, the markets are sanctioning bad policies, sometimes excessively, disproportionately and based on rumours and prejudices.”
Mr Van Rompuy said financial markets had contributed to the eurozone’s crisis by being too soft on fiscally irresponsible governments in the years after the euro’s creation in 1999. He criticised the French and German governments of the early part of the decade for relaxing the stability and growth pact – the EU’s fiscal rulebook – in 2005. “This sent the wrong signal,” he said.

Europe’s biggest challenge was to introduce reforms required to double the EU’s economic growth rate and safeguard its unique blend of vigorous capitalism and a generous welfare state. “The toughest thing now is reforms in the budgetary field and the economy – competitiveness, labour market reforms, the retirement age,” he said.
“Of course, it will be difficult. At certain times there will be social unrest and political opposition to all this. But I know most of the leaders now. They are preparing to take huge risks because they know what is at stake for the eurozone.”

Friday, 11 June 2010

Addressing China's exchange rate policies

Yukon Huang, a former country director for the World Bank in China, opined in an article in Financial Times that China must adopt a flexible exchange rate policy:
The plunge in the euro and threat of persistent economic instability has caused the Chinese government to take a more cautious approach to adjusting its exchange rate. But ironically, the collapse of the euro presents a golden opportunity for China to introduce greater exchange rate flexibility. China should do this now, rather than wait for the crisis to abate. And to the surprise of many, it should begin by letting the value of the renminbi depreciate rather than appreciate.
Chinese authorities have been reluctant in the past to appreciate the exchange rate in response to global pressure because when markets are convinced that the renminbi will rise – even gradually – in value over the foreseeable future the rise will encourage speculative capital inflows. Over the past decade, estimates suggest that perhaps 20-40 per cent of the annual capital inflows have been “hot money” pursuing the likelihood that the currency would appreciate either steadily or in measured steps. Such inflows intensify pressure for further appreciation and create negative results that China is already struggling to address.
Damaging consequences include excess liquidity and lower than desired interest rates that help push up investment – notably real estate – to unsustainable levels, and raise the prospect of a major collapse in asset values. Housing prices in Beijing and Shanghai are clearly inflated and demand continues to grow unabated. While unit values have doubled in many cases in the past year, rents are stagnant. Apartments remain empty as owners wait to “flip” their holdings. With these concerns, one-way bets on the exchange rate are not something China should encourage.
There are two problems with China’s exchange rate: one, the value of the renminbi and, two, its flexibility. Despite conventional wisdom, it is actually more important to tackle the latter first, rather than fretting about the former. China and the rest of the world have more to gain from Beijing adopting a flexible exchange rate.
The renminbi has been pegged to the US dollar for nearly two years and since November the euro has fallen nearly 20 per cent against the renminbi. Given the importance of the European market to China – and east Asia as a whole – the renminbi’s sharp appreciation relative to the euro provides China with an opening to begin the process of allowing the renminbi to fluctuate within a wider band. Chinese officials have publicly indicated they would allow this. Initially, the renminbi – to the surprise of many – could depreciate a few percentage points relative to the dollar before going up, due to the temporary turbulence in the eurozone.
China’s key objective should be to move to a more flexible exchange rate system that does not have any pre-ordained bias in moving up or down. When China broke the fixed peg to the dollar in 2005, it embarked on a steady but gradual appreciation of the renminbi until August 2008, when the renminbi was repegged to the dollar.
During this period, the unspoken rule was that the rate of appreciation would not exceed 6-7 per cent a year. Anything more than 7 per cent would encourage excessive capital inflows as investors would be guaranteed an attractive return after allowing for differentials in interest rates between financial centres and the costs of transactions for moving funds across markets. Even with an appreciation of about 20 per cent over these three years, capital inflows continued and pressures to appreciate did not fade.
With pressures building over the past two years, market watchers are speculating that the needed adjustment is much larger than a gradual appreciation of 6 to 7 per cent. Still, the government remains adamantly against any major or sudden adjustments and reluctant to embark once again on a gradual appreciation in one direction that would not necessarily solve the problem – and, in fact, could make it worse.
The question remains: if the market determined the value of the renminbi, would it be higher or lower in five years? It is widely believed that the currency would appreciate owing to persistent trade surpluses and China’s abundant foreign reserves. But, even with the lack of movement in the renminbi’s value, China’s competitiveness is already eroding as inflation accelerates, pressures for significant increases in real wages mount, and property values continue to rise. Perhaps the most challenging aspect for the government is the pressure on labour markets as reflected in the highly publicised strikes in southern China, which reflect not so much a shortage of labour per se but more the unwillingness of the newer generation of migrants to relocate when equally attractive opportunities nearer to home are now emerging.
It is also worth noting that most Chinese households and companies find it difficult to move funds abroad given existing capital controls. Many have yet to consider the possibility that owning property in another country could be even more attractive. But with growing sophistication in considering investment alternatives and greater flexibility in transferring funds, the Chinese – like all others with significant assets – will diversify their holdings more quickly by shifting capital abroad. Prudently diversifying assets could mean the renminbi will get weaker rather than stronger over time on a “market basis”. Its value in the next few years is anyone’s guess – the way it should be.

Tuesday, 1 June 2010

A New European Attitude Needed

Cees Bruggemans, chief economist of the FNB Group, posted the following thoughts about the structural problems prevailing in Europe:


It has been startling to watch Europe turn frugal overnight, Germans preparing to bail the weak and the ECB promising NOT to do certain things (and then doing them).

To what purpose?

They are all desperately trying to buy time in the absence of the one thing really needed to keep the debt dragon contained and successfully address the centrifugal forces tearing the Euro apart.

That something is the absence of growth. Old Europe (recalling Donald Rumsfeld) remains woefully ex-growth.

Bits here and there impress (the German export engine, north Italian creativity and fashion, Dutch trade).

But much more of Europe is without it. The Italian south sponging on its north. The endemic Spanish unemployment. And now we discover Greece and Portugal and their problems. Italy and Portugal in recent years have barely averaged 1% growth.

All these countries have rigid labour markets, high structural unemployment, inefficient bureaucracies, too many monopolies. Overdue supplyside reform is needed, indeed revolutionary stuff.

But this is not limited to the distressed countries. Germany also needs supplyside reform in order to generate more domestic growth than its export engine can generate.

Europe needs to grow, growing its tax revenue base, outdistancing its debt, making debt loads sustainable.

As the German Minister of Finance noted, you want Germany to grow more, but you don�t want him solely doing the pushing by increasing government spending or widening the fiscal deficit.

Instead, more long-term German unemployed need to be productively re-absorbed (thereby also assisting fiscal contraction through reduced welfare payments).

In the case of the distressed Club Med, these countries should function well even if the government bureaucracies were HALVED in size. Not that this is going to happen to quite this extreme degree, but it indicates the extent of available scope. In addition, their already far too many long-term unemployed need to be reabsorbed.

That means far more flexible labour markets, easier exits and entries and lower wage rates WITHOUT welfare incentives to stay on the sidelines longer than needed.

The present European welfare state is dying, its luxuries unable to be maintained at such low growth rates if it means steadily higher debt burdens.

So the spectacle of macro policy bending over backwards to ease market liquidity and prevent debt default is merely an attempt to create space time in which Europe will need to do something far more fundamental.

Europe needs to change its operating style, become again hungry for growth and less lifestyle preoccupied while encouraging rather than preventing competition (between vested interests and labour elites) or condoning large swaths of non-productive bureaucracy.

This sounds easy, right?

But even a casual stroll through the enchanting Club Med countries AND the richer parts of Europe tells you it won�t be. Indeed, some think it outright impossible, perverse even. If it was that easy, it would have been tried long ago. But they didn�t, for a reason.

Modern Greece is really an ex-Balkan state with its Ottoman feudal foundations rehashed into a local client state run by a small elite and greased by corruption in which private initiative cannot flourish.

The other country cultures similarly suffer from age-old afflictions which aren�t easy to jettison in favour of what a modern market economy requires.

The resulting debate falls into two distinct parts.

Namely those who feel different spirits don�t belong together and should split. And those who feel they do belong together for the simple reason of occupying the same space (home), but requiring offers from the weak as much as the strong to be workable.

On a ten year view, the true European revolution won�t be fiscal cleanup as budget deficits are shrunk and spiraling debts are arrested, or even the audacious manner in which the ECB of late is imitating the Anglo-Saxon central banks in preventing country defaults from gumming up the region and risking costly splits.

Instead, the real challenge is structural, aiming to restart economic growth akin to Europe�s post-war reconstruction. Annual growth of 1% in parts and near 2% overall isn�t enough. As the US has shown, GDP growth of 3% or better is what is needed, also bearing in mind the aging challenge.

The creative destruction of war and its aftermath can unleash such rejuvenation. Can the threat of financial unraveling?

Or are there easier outcomes, such as falling back on national currencies, taking the easy route, simply devaluing the currency often, even if this comes at the expense of a greater growth dynamic remaining out of reach (crises again becoming the regular stuff of life)?

There is a lot of fear driving Europe, about past disasters, future competition, how to pay for ageing and not wanting to lose the welfare advantages achieved.

But are these, and the fear of total financial loss, enough to transform European supplysides, overcoming inertia and ideological opposition (ideas), never mind vested interests richly served by the sclerotic present?

We are about to find out these next few years. Expect lots of water in the wine, but also genuine effort. The trick is not to confuse the two.

Report: investors chase hedge fund performance “naively and at all costs”

Report: investors chase hedge fund performance “naively and at all costs”

Wednesday, 26 May 2010

Roubini's views

Some excerpts from RGE Monitor:

After bottoming in Q2 2009, world trade volumes have grown steadily since H2 2009, with momentum continuing into early 2010. Emerging markets (EMs) are driving the trade recovery with their imports approaching the 2008 peak. In early 2010, emerging Asia’s exports and imports crossed their 2008 peaks as regional domestic demand, inventory restocking in Asia and abroad, and Chinese commodity demand boosted intra-Asia trade.
Domestic demand has fueled a sharp rise in LatAm imports while its exports approached the 2008 peak, helped by strong commodity exports and reviving U.S. demand. The Middle East and Africa’s trade has also revived decisively, whereas deleveraging and fiscal austerity are weighing on Central and Eastern Europe’s trade. While Asian demand has supported Japan’s exports, U.S. and eurozone exports and imports are still over 10% shy of their 2008 peak due to a slow recovery in domestic consumption.
After plunging in 2009, investment is recovering due to strong government investment and improving capex in EMs and advanced economies. Replacement of capital and fiscal incentives for capex and automobile purchases are boosting global trade in capital goods, automobiles and auto parts and components. But trade volumes were still 7.0% below their 2008 peak as of early 2010
And now, debt crisis and fiscal austerity in the eurozone and potential trade and financial contagion to the rest of the world threaten to stifle the global trade recovery in 2010 and increase protectionism and trade finance costs. Aggressive fiscal cutbacks in periphery eurozone countries have arrived earlier than expected, which—along with a weak euro—are likely to reduce the EU’s import demand starting in 2010. This will affect global trade in consumer and capital goods since the EU accounts for nearly 40% of global imports and is a key export destination for the world’s major economies. The euro weakness will boost EU exports, especially those of competitive countries like Germany and the Netherlands.
The current crisis would also force core eurozone countries and those with vulnerable fiscal outlooks to undertake fiscal austerity as soon as 2011, weighing on private demand and imports. Developed economies’ imports are expected to recover sluggishly amid slow recovery in consumption and capacity utilization. Imports of EMs with large domestic demand and any expansion of global fiscal stimulus will fail to offset weaker import demand from the eurozone and other economies. Due to these factors, global trade momentum will ease over the course of 2010 and grow at a slower pace in 2011. RGE forecasts world trade volume to grow 7.5% in 2010, with downside risks, following a contraction of 12.2% in 2009.

PIIGS markets all in bear territory European Stocks to Watch - MarketWatch

PIIGS markets all in bear territory European Stocks to Watch - MarketWatch

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Missing the point

Eric Rasmussen of FA-mag.com writes about the typical behavioral mistakes retirees make at retirement:

The period right after retirement, when people have just stopped working, can be the most critical period for investors, say experts, and yet it’s also a time when people make decisions with their guts that they ought to be making with their heads. People are often unwilling to take risks during this period—say, by keeping investments in the stock market. Yet at the same time they’re ignoring the risk of longevity, or what might happen with their money if they live another 30 years and have to deal with the inflated costs of food, shelter and (even more sobering) health care. Imagine trying to spend 1986 dollars on health care today.
So it goes that behavioral finance has become the topic du jour, and insurance company Allianz has gone out and plumbed the thinking of 10 experts in the area, creating a report called Behavioral Finance and the Post-Retirement Crisis. The report discusses why investors make certain decisions about products like annuities, then digs into why that behavior might not always be in their best interests. It also considers how such behavior might be changed.
One observation of the report is that retiree aversion risk is often greatly amplified. Professor Eric Johnson of Columbia University recently worked with the AARP and the American Council of Life Insurers to look at risk-taking behavior. Where normally a gambler in Atlantic City would risk a $3 loss to make a $6 gain, retirees are in the woodshed by that time.“Nearly half of the retirees said that they would refuse a gamble with a 50% chance of winning $100 and a 50% chance of losing as little as $10, which suggests they weighted losses about 10 times more heavily than gains,” says the report.
And that kind of aversion can have a dramatic effect on what they do with money after they retire—say, when they are faced with the choice of taking a lump sum distribution of money or annuitizing. Johnson says that handing over the money to an insurance company can seem like “losing” the money, and because the psychological effect is double, handing over $250,000 can seem like handing over half a million, he says.Investors might also not realize that they’re thinking in terms of nominal dollars not real dollars. Professor Jeffrey Brown of the University of Illinois found that an investment spurned by retirees when framed one way might be embraced when it is framed another way. He took a $100,000 savings account with 4% interest and put that in front of 1,300 people older than 50, asking them if they preferred that to a life annuity paying $650 a month. The two choices were actually designed to have the same actuarial value. But only 21% liked it when it was positioned as an investment, whereas 70% preferred it when it was positioned as a monthly income stream, not an investment. The investment moniker had more risk associated with it. Such behavior has come under greater scrutiny as investors continue to reel from the financial crisis. People tend to take a rear-view mirror view to the choices they make, says the report. “I find a very strong negative relationship between a bad stock market return and annuitization,” said Alessandro Previtero, a fellow at the Anderson School of Management at UCLA, at the press meeting. “After a negative trend in the stock market, individuals are more likely to take an annuity. After a positive time, they are more likely to take the lump sum.” “People make long-term binding financial decisions based on the last six months of the stock market,” echoed Shlomo Benartzi, a professor and co-chair of the behavioral decision-making group at UCLA. Benartzi said that the behavioral finance element of an advisor’s work will become more important as investors become more responsible for their own decision-making in the defined contribution era.

Wednesday, 19 May 2010

The Second Stage of the Financial Crisis....

Not even the U.S. is safe any more from bond investors who may realise government debt is unsustainable says Nouriel Roubini as reported by Businessweek:

“Bond market vigilantes have already woken up in Greece, in Spain, in Portugal, in Ireland, in Iceland, and soon enough they could wake up in the U.K., in Japan, in the United States, if we keep on running very large fiscal deficits,” Roubini said at an event at the London School of Economics yesterday. “The chances are, they are going to wake up in the United States in the next three years and say, ‘this is unsustainable.”
The euro slid to the lowest level in more than four years against the dollar today as a German ban on some speculative trading fueled concern the European debt crisis will worsen. Roubini suggested the public debt burden incurred after the 2008 bank panic may now cause the financial crisis to metamorphose.
“There is now a massive re-leveraging of the public sector, with budget deficits on the order of 10 percent” of gross domestic product “in a number of countries,” Roubini said. “History would suggest that maybe this crisis is not really over. We just finished the first stage and there’s a risk of ending up in the second stage of this financial crisis.”
Roubini, who predicted in 2006 that a financial crisis was imminent, said that the record U.S. budget deficit may persist amid a stalemate in Congress between Republicans blocking tax increases and Democrats who oppose cuts in spending.
“In many advanced economies, the political will to do the right thing is constrained,” he said.
The U.S. posted its largest April budget deficit on record as the excess of spending over revenue rose to $82.7 billion. The federal debt is currently projected to reach 90 percent of the economy by 2020.
Roubini, speaking in a lecture hall packed with students who then queued to meet him at a book-signing, reiterated that the euro region faces the threat of a breakup after the Greek budget crisis. The European Union said yesterday it transferred the first installment of emergency loans to Greece, one day before 8.5 billion euros ($10.4 billion) of bonds come due.
“Even today there is a risk of a breakup of the monetary union, the euro zone as well,” Roubini said. “A double dip recession in the euro zone” is “something that’s not unlikely, given what’s happening.”

Friday, 7 May 2010

The Return of Fear Across The Globe...

Financial Times reports on the latest market developments about the European Debt Crisis:

Worries about European sovereign debt turned suddenly into one of the market’s sharpest corrections since the crisis began.

A four per cent drop in Chinese stocks started the downbeat mood, but Wall Street added an exclamation point. Later in the afternoon, the S&P 500 index took its biggest plunge since December 2008, erasing its 2010 gains in a matter of moments. It was down at one point 8.6 per cent, to 1,065.93.

The VIX index of market volatility spiked nearly 40 per cent to 40.71, to highest level in a year – and its sharpest one-day jump since February 2007.
“It’s really shocking,” said Jeff Palma, global equity strategist at UBS. “Stocks fell to minus nine on the year within seconds, that was a pretty shocking move. This is not your normal every day pull back, this is a pretty full-on collapse in risk appetite.”
Images of Greek protesters taking to the streets in opposition to austerity measures matched an accelerating decline in the euro. Meanwhile, the European Central Bank said it would keep its interest rate at 1 per cent, and would not begin buying sovereign debts.
Markets have been rocked over the past few days as the danger to the global economy of unsustainable budget deficits has hit home hard. Riots in Athens have illustrated how the severe austerity measures designed to tackle such deficits have implications not just for economic growth but also for social cohesion.
The dollar and highly-rated government bonds have been pushed sharply higher on haven flows, and commodities corrected to year lows, notably oil trading near $75 a barrel.

In spite of fear emanating from sovereign risk, the beneficiary of the anxiety was the world’s deepest haven market, the 10-year US Treasury. The benchmark fell 15 basis point to 3.38 per cent, having earlier tumbled 28bp. 30-year Treasuries at one point tumbled 30bp lower, to 4.06 per cent, their lowest level since March 2009.

Wednesday, 5 May 2010

Nouriel Roubinis' RGE Monitor reports on the latest developments in Europe dealing with the debt crisis in Greece and perhaps other countries.

Even as the IMF and the eurozone have virtually finalized an unprecedented three-year financing package of €110 billion for Greece, financial markets remain unimpressed. The common currency continued to plunge this week and long-term government bond yields in Greece and in the periphery countries, including Italy, spiked upward again after a short relief rally before the agreement. The market’s lukewarm reaction to the financing package confirms RGE’s view that a traditional financing package extended at unsustainable interest rates, will not allay solvency fears but rather will lead to a disorderly outcome and contagion.
Plan A includes the following core elements: €80 billion in bilateral loans will be provided by the eurozone at annual interest rates of about 5%, according to a previously negotiated formula, and €30 billion (i.e. 32 times quota) by the IMF through a standard stand-by arrangement. Although some eurozone member states—including Germany, which is facing regional elections on May 9—still have to ratify the unpopular disbursement, a new consensus has emerged among authorities and opposition that the main issue is not Greece per se but the gathering contagion to the rest of the eurozone. Unanimous approval by eurozone heads of state is due on May 7 at a special summit, following fresh reports that the Slovak government is holding up the disbursement for domestic election purposes.
The additional measures agreed by the Greek authorities will result in a front-loaded fiscal retrenchment of about 11 percentage points of GDP over three years with the aim to reducing the deficit below 3% of GDP by 2014. About half of the deficit reduction will come from expenditure cuts, the other half from tax increases and a broadening of the tax base, including from previously undocumented income. Greek authorities have accordingly revised down their growth forecast to -4.0% in 2010 and -2.6% in 2011 for a cumulative GDP volume retrenchment of 8.6% starting 2009. The debt ratio is expected to continue increasing, peaking at almost 150% of GDP by 2013 before starting to decline in 2014.
The major banks have already been downgraded to junk status by S&P, and other rating agencies might follow suit. Importantly, against previous assurances that the ECB would not ease the rules for one country alone, in an unprecedented U-turn the ECB has decided to suspend the minimum rating threshold for any Greek collateral with the ultimate aim to encourage investors to hold on to their investment. Indeed, as of the end of 2009, European banks hold claims of US$193 billion on Greece and more than US$1 trillion of further claims on Portugal, Ireland and Spain.
It cannot be ruled out that the ECB will eventually have to resort to more aggressive measures such as buying government bonds in the secondary market in order to stop the contagion.

Wednesday, 28 April 2010

Preparing for the worst...

Risk.net comments on the latest measures by banks to protect themselves from a potential escalating debt crisis in Europe.
With markets anticipating a Greek debt restructuring, bank traders and risk managers are preparing for a wider crisis that could drag in northern European countries, tip the euro into a tailspin or even threaten the eurozone’s integrity.
Banks are shorting the euro, along with German and French government bonds, as a hedge against an escalation of the Greek debt crisis. Their fear is that a Greek restructuring is inevitable and will scare investors away from other vulnerable members of the eurozone. One obvious consequence would be a weakening of the single currency, but banks have entertained a variety of other, wilder scenarios as they seek to immunise their books against a possible Europe-wide crisis.
"The big question for us, though, is how bad the contagion will be into northern Europe, the UK and the US." The problem for banks is the potential range of outcomes. An agreement by the International Monetary Fund (IMF) and European Union (EU) on April 11 to provide a €45 billion standby aid package initially seemed to ease pressure on Greek assets. It quickly proved to be a false dawn. Yesterday, as Standard & Poor's downgraded Greek debt three notches to junk territory, and a German government official suggested Greece might need to exit the eurozone, the cost of five-year credit default swap (CDS) protection on Hellenic Republic debt hit a new high of 710 basis point, roughly twice the level seen in mid-April.
Commentators are still split on whether a restructuring will happen sooner or later - but banks should, by now, be protected, says the London-based market risk head at a large UK bank: "If Greece defaults tomorrow and some bank stands up and says ‘I've lost a billion dollars on Greece', they should fire everybody. Greece is a very old story. What we're trying to figure out is what happens next. Is it Portugal? Italy? Spain?"

Or something even nastier. Some analysts have suggested that if the capital markets close to other eurozone countries, forcing them to go cap-in-hand to the EU, it could test the commitment of countries like Germany to economic union - richer nations could choose to go it alone, or they might just boot out the weaker countries. The consequences for European assets would be enormous.

"Germany pulling out of the eurozone would be great for Germany and terrible for everybody else," says one European bank's market risk head. "But it doesn't have to be that. You can imagine some statement from the EU saying the enlargement project is on hold, so the Czech Republic, Poland, and Hungary get caned. You really have to look at anything related to the EU including potential break-up. There's a pretty much unlimited set of scenarios."
Based on CDS spreads, the market sees contagion to other, weaker countries as the next likely step. Spreads on Portugal and Spain have more or less doubled in recent weeks. Portugal was trading at 157bp as recently as April 13 and hit 315bp on April 27 as it too was downgraded. Spain has leapt from 93bp to 188bp in roughly the same period.

Monday, 19 April 2010

Beware the global imbalances!

One of the "culprits" of the recent financial crisis has been the global imbalances between the surplus and deficit countries. Most notably it was seen by the enormous US deficits and China's massive trade surplus. The European Central Bank (ECB) recently issued a warning that not much has changed and that global economic recovery is under threat. The Financial Times reported:

The ECB has made clear its fear that governments are not doing enough to put the global economy back on a sustainable growth path – despite international policy initiatives in the past year. “At the current juncture, global imbalances continue to pose a key risk to global macroeconomic and financial stability . . . The stakes are high to prevent a disorderly adjustment in the future that would be costly to all economies,” it concludes in a special article in its monthly bulletin published on Thursday.

The ECB argues that the 16-country eurozone had “remained very close to external balance”, even though the large trade surplus of Germany, its largest member, is seen by many economists as restricting growth prospects elsewhere in the region.

Since the outbreak of the crisis, the imbalances have narrowed. However, the report argues that such trends are likely to be temporary. Cyclical factors that led to a narrowing, such as lower oil and commodity prices, have gone into reverse. At the same time, structural factors that contributed to the build-up in imbalances remain – including the lack of a social “safety net” in emerging Asian economies, which has encouraged domestic saving, and the desire of countries to build up reserves as insurance against future crises. Moreover, differences in growth rates have widened, with export-led emerging economies becoming an increasing source of global growth, the ECB adds.
Speaking in Washington, J├╝rgen Stark, ECB executive board member, said Asian emerging market economies were powering global growth, with prospects still weak in many advanced economies. “Questions can be raised as to whether such an uneven pattern of the recovery will prove sustainable.”
He warned that advanced economies would “continue to face severe macro-economic imbalances in the years to come”, as highlighted by the dramatic deterioration in public finances. “We may already have entered the next phase of the crisis: a sovereign debt crisis.”
Mr Stark concluded: “There is no doubt that the crisis will leave us a heritage of severe macro-economic imbalances. Dealing with them will represent one of the most daunting challenges for policymakers in modern history.”

Thursday, 15 April 2010

China does it again, and at a faster rate...

The Chinese economy is continuing to grow at a rapid pace but with concerns about overheating. Financial Times reports:


The Chinese economy expanded at an accelerated rate of 11.9 per cent in the first quarter. The economy grew at the fastest rate in nearly three years and more quickly than economists had expected. The pace of growth puts new pressure on Beijing to consider tougher tightening measures, including appreciating the exchange rate and increasing interest rates.

House prices increased by 11.7% over the past 12 months - the fastest rate since the figures were first published five years ago and prompting new concerns about a potential bubble in the property market.

Despite rising fears of overheating, consumer price inflation dipped to 2.4 per cent last month, from 2.7 per cent in February. However, factory-gate inflation continued to accelerate, increasing from 5.4 per cent to 5.9 per cent in March.
The government has already taken some steps to reduce the stimulus it is injecting into the economy, including much tighter control over bank lending in March. However, domestic concerns about potential inflation come at a time of growing international pressure to abandon China’s de facto currency peg against the US dollar.

Tuesday, 13 April 2010

The blaming game...

Alan Greenspan, once regarded as the hero of the financial system before its implosion in 2008, recently had to appear before a Financial Crisis Inquiry Commission (FCIC) meeting on Capitol Hill explaining his role, or rather the lack of preventing an economic meltdown at the helm of the Federal Reserve. Financial Times reported on the events of this dramatic hearing:
Phil Angelides, who leads the FCIC, asked the former chairman of the Federal Reserve if the Bank’s failure to curb subprime lending as the housing bubble unfolded fell into the category of “oops”. “My view is, you could have, you should have and you didn’t,” Mr Angelides said.
Mr Greenspan, 84, led the Fed between 1987 and 2006 and has been criticised for helping foster the conditions that led to the collapse of US mortgage markets and, ultimately, the global financial crisis two years after his departure.
“In the business I was in, I was right 70 per cent of the time, but I was wrong 30 per cent of the time”, Greenspan said. “What we tried to do was the best we could with the data that we had.”

Mr Greenspan said it was likely that Congress would have blocked any attempt by the Fed to rein in the subprime mortgage industry, since it was bolstering home ownership across the country. He said lawmakers were now suffering from “amnesia” about their stance on the issue.

In his opening statement, Mr Greenspan said there was no evidence that Fed monetary policy during his tenure contributed to the housing bubble. He argued that it was low long-term interest rates, not the short-term rates that the central bank controls directly, that nourished the proliferation of subprime mortgages. “The house-price bubble, the most prominent global bubble in generations, was caused by lower interest rates but . . . it was long-term mortgage rates that galvanized prices, not the overnight rates of central banks, as has become the seeming conventional wisdom,” Mr Greenspan said.
He also noted that the Fed did not regulate many of the independent mortgage companies that issued subprime loans during the bubble, and lacked enforcement powers to protect consumers more aggressively.
Mr Greenspan said higher capital and liquidity requirements for banks and increased collateral requirements for financial products would mitigate future crises.
“The next pending crisis will no doubt exhibit a plethora of new assets which have unintended toxic characteristics, which no one has heard of before, and which no one can forecast today,” Mr Greenspan said. “But if capital and collateral are adequate, and enforcement against misrepresentation is enhanced, losses will be restricted to equity shareholders . . . Taxpayers will not be at risk.”

Monday, 12 April 2010

The next set of asset bubbles...

Kenneth Rogoff, Harvard professor and co-author with Carmen Reinhart of "This Time is Different: Eight Centuries of Financial Crises" should know something about price bubbles. He discussed the prospects of new bubbles forming in an article published in the Financial Times:
As the global economy reflates, many people are asking: “Is the next bubble in gold? Is it in Chinese real estate? Emerging market stocks? Or something else?” A short answer is “no, yes, no, government debt”.
We find that debt-fuelled real estate price explosions are a frequent precursor to financial crises. A prolonged explosion of government debt is, in turn, an exceedingly common characteristic of the aftermath of crises. But a deeper question is whether economists really have any handle on ferreting out dangerous price bubbles. There is much literature devoted to asking whether price bubbles are possible in theory. I should know, I contributed to it early in my career.
In the classic bubble, an asset (say, a house) can have a price far above its “fundamentals” (say, the present value of imputed rents) as long as it is expected to rise even higher in the future. But as prices soar ever higher above fundamentals, investors have to expect they will rise at ever faster rates to make sense of ever crazier prices. In theory, “rational” investors should realise that no matter how many suckers are born every minute, it will be game over when house prices exceed world income. Working backwards from the inevitable collapse, investors should realise that the chain of expectations driving the bubble is illogical and therefore it can never happen. But then along came some rather clever theorists who noticed that bubbles might still be possible (in theory), if we lived in a world where the long-run risk-adjusted real rate of interest is less than the trend growth rate of the economy.
The real issue is not whether conventional economic theory can rationalise bubbles. The real challenge for investors and policymakers is to detect large, systemically dangerous departures from economic fundamentals that pose threats to economic stability beyond mere price volatility.
The answer is to look particularly for situations with large rapid surges in leverage and asset prices, surges that can suddenly implode if confidence fades. When equity bubbles burst, investors who made money in the boom typically swallow their losses and the world trudges on, for example after the bursting of the technology bubble in 2001. But when debt markets collapse, there inevitably follows a long, drawn-out conversation about who should bear the losses. Unfortunately, all too often the size of debts, especially government debts, is hidden from investors until it comes jumping out of the woodwork after a crisis.
In China today, the real problem is that no one seems to have very good data on how debt is distributed, much less an understanding of the web of implicit and explicit guarantees underlying it. But this is hardly a problem unique to China.
The timing is very difficult to call, as always, but even as global markets continue to trend up, it is not so hard to guess where bubbles might be lurking.

Wednesday, 7 April 2010

Turning the corner?

Financial Times reported on the latest employment figures coming out of the United States:

The US economy created 162,000 jobs last month as the unemployment rate remained unchanged at 9.7 per cent, the government said on Friday, bolstering hopes that the economic recovery is gathering steam.
The economy shed about 8.4m jobs during the recession, as employers made severe cutbacks and learned to cope with a leaner workforce. Productivity soared to historically high rates last year.
The Obama administration, which has been under pressure to find a solution to persistently high unemployment, welcomed the gains.
High unemployment has been a key reason why the Federal Reserve has maintained rates at historically low levels. At last month’s meeting of the Fed’s interest rate setting committee, monetary policy makers said rates would remain at their current range of 0-0.25 per cent for an “extended period”.
The construction and manufacturing sectors, which suffered some of the biggest job losses during the downturn, respectively added 15,000 and 17,000 positions in March. But weakness in the financial industry continued, as companies shed 21,000 jobs. Overall private sector payrolls increased by 123,000 jobs, a big improvement over gains of 8,000 in February and 16,000 in January.

Why some financial advisors are much better than others

FA news (USA) reported why some financial advisors are doing much better than their peers:
The best advisors aren't just beating their peers. The numbers show them practically pounding them into the ground. A recent survey of more than 1,000 financial advisors by consulting firm Quantuvis Consulting reveals that the top 25% in the business generate total average annual revenue of $1.2 million—more than five times the $225,000 in annual revenue that other advisors enjoy. Even more important, the top 25%—a group Quantuvis calls 1QAs—earn $225,800 in operating profits on average, versus just $44,400 for the rest. "It tells us there is an inflection point in a practice's growth where you see exponential gains in performance," says Quantuvis Chief Executive Officer Stephanie Bogan.
Bogan sees three primary drivers behind success:
1. Commitment to the wealth management business model. It is the dominant business model among 1QA advisors, used by 52% of this group. The most common business model among the non-1QAs is financial planning (32%). Just as important as the model, says Bogan, is the top advisors' commitment to it. "The top wealth managers operate proactively, not reactively. They're disciplined and systematic in their approach, and they've segmented their clients and service offering to deliver wealth management profitably," she notes. "Lots of firms segment their clients but don't do anything with the information."
2. A focus on a fee-based revenue model. 1QA firms generate far more revenue from fees than other firms ($670,243 versus $67,631 on average). Also, their fee-based revenue is three times greater than all other revenue sources combined. That focus is also evident in their client base: More than half are fee-based, versus just 30% of non-1QAs' clients."In a commission-based business, the advisor must essentially start over at the beginning of each year. In a fee-based business, revenue might be lower initially but the lifetime value of each client is like an annuity that builds," says Bogan. "As a firm grows, it builds up its base of recurring revenue from fee-based assets. And that allows the owner to focus on service and improving business performance instead of just focusing on selling more stuff to recreate the revenue stream."
3. Significant operational leverage. Top advisors make better use of their resources than do less successful advisors, giving them more time to focus on client service and business development. For example, the 1QA advisors tend to use technology and take advantage of opportunities to outsource more than their peers. Two-thirds of 1QA advisors (66%) use customer-relationship-management software, compared with just under half (49%) of non-1QAs. What's more, 1QA advisors are more likely to outsource a variety of functions--bookkeeping, payroll processing and the like--to third-party providers."
A practice's greatest asset is its advisors' time," says Bogan. "In a factory, the machinery that turns out goods is maintained for optimal efficiency. In an advisory practice, the advisor is the income engine. If it's clogged up doing paperwork or scheduling appointments, the engine isn't running optimally."She's quick to point out, however, that operational leverage doesn't necessarily mean getting bigger. "A two-person firm that outsources its investment management duties and uses technology well can have better operational leverage than a six-person firm that doesn't do either of those things."