lunes, septiembre 15, 2014

THE ' 70s IN REVERSE / BARRON' S MAGAZINE

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STREETWISE

The '70s in Reverse


The Fed must let the data, not a timetable, guide future rate hikes.

Sept. 13, 2014 3:23 a.m. ET

There are mistakes, and then there are mistakes. Misspell a name on a quiz, for instance, and you might get 5% knocked off your grade. Misspell a name on a loan agreement, and you could knock a few percentage points off your share price as investors ponder whether the documents themselves are fraudulent. That's what happened to Nu Skin (ticker: NUS), a skin-care company, earlier this month.
The Federal Reserve has managed to avoid serious mistakes as it slowly brings monetary policy back to something resembling normal. After the initial "taper tantrum" that occurred last year at the Fed's first mention of a reduction in its bond-buying, the economy and stock market have calmed down. Even recent changes to the Fed's language have done little more than keep investors up to date with the central bank's thinking. Thus, no one ought to be caught by surprise when the first rate hike occurs.
Still, one thing the Fed could do at its next meeting, scheduled for this week, would be an error: It could set a timetable for a rate hike. The pressure on Fed Chair Janet Yellen and her team to "do something" has been ratcheting up, as the job market has generally improved and economic growth has strengthened. And the voices inside the Fed that have been calling for a rate hike have grown stronger.
If the Fed were to abandon its data-dependent framework in favor of a firmer timetable before the economy is ready, watch out. "It's worse to tighten when you haven't reached escape velocity," says Dennis DeBusschere, a strategist with International Strategy & Investment Group. "The odds of a potential mistake are increasing."
It isn't hard to see why the hawks might be itching for a rate hike. Just last week, we learned that consumer confidence is at a 14-month high; consumer spending might be a bit stronger than was thought; and the job market continues to heal, despite a slight uptick in jobless claims. And if that were all, setting the course for the first rate hike would be not only understandable but also good for stocks, which tend to follow rates higher if accompanied by stronger economic growth and rising inflation expectations. That was the case starting in June 2004, when the Fed hiked rates 17 consecutive times in two years, while the stock market rose 12%. "The Fed can raise rates gradually, and it doesn't have to be bad for the market," says New York University financial historian Richard Sylla.
Unfortunately, the U.S. economy might not be in that position quite yet. Incomes, if no longer stagnant, are just inching their way higher. Housing remains in the doldrums as potential buyers cite insufficient savings, excess debt, poor credit scores, and, yes, their incomes as stumbling blocks on the road to home ownership. Higher rates won't fix any of those problems, and even setting a schedule for rate hikes could create head winds if it causes loans to become harder to get in anticipation of the change.
The history of central banking is littered with mistakes big and small. There were the Federal Reserve's rate hikes in 1931, which helped exacerbate the early turmoil of the Great Depression, and the rate increases later in the decade that helped prolong it. Looking overseas, we're still shocked that the European Central Bank hiked rates in 2011, doing its part to ensure that Europe's recovery would never gain even the limited traction seen in the U.S.
Even Paul Volcker's decision to hike rates to 19.1% in June 1981 -- more than double what they had been the year before -- initially was viewed as a mistake. And no wonder: Unemployment surged, the S&P 500 tumbled, and farmers tried to blockade the Fed building with their tractors. Still, there's little arguing with the results, as inflation's taming set the stage for a nearly two-decade expansion.
IN THE 1970S, high inflation wasn't just imagined -- it was very real. Today, however, those clamoring for rate hikes seek to head off potential threats -- of higher inflation, asset bubbles, and the like -- and ensure that U.S. growth continues to accelerate. In fact, inflation expectations in the U.S. have been falling recently, not rising. The risk becomes that the U.S. ends up repeating the '70s in reverse. Remember, in that decade, rates weren't hiked enough, causing inflation to reignite quickly, which never solved anything. Today, tighter policy could mean the economy never reaches escape velocity, instead remaining mired at 2% growth. And that's a mistake we don't want to make.
The good news: Stocks could get a boost if yields stay low for longer. Deutsche Bank's David Bianco, for one, estimates that if the yield on the 10-year U.S. Treasury note stays below 4% for several years, it would lower the real cost of equity to 5.5% from 6%. While the change doesn't seem like much, it had a big impact on Bianco's forecasts for the Standard & Poor's 500: He raised his 2014 price target for the S&P 500 to 2050 from 1850, and thinks it could finish next year at 2150, up from 2000.
The S&P 500 closed at 1985.54 last week. 


Relationship Problems

As global conflict escalates, Fed policies keep Wall Street calm. Plus, more trouble for Trump in Atlantic City.


Breaking up still is hard to do, and it can be frightfully expensive to boot. Voters in Scotland nonetheless seem undeterred by that prospect as they head to the polls on Thursday to consider whether to sever their three-centuries-old tie with England, which could create what might be called "Not So Great Britain."
You'll be forgiven if the Sept. 18 referendum on Scottish independence had eluded your notice, as it had for most on the western side of the pond. And it had not aroused much attention in the markets so long as rejection of an independent Scotland and an intact United Kingdom seemed the likely outcome of the vote.
But a poll showing a pro-independence "Yes" vote eking ahead shocked the markets and sent sterling into a tailspin. The British establishment was roused to warn of the dire economic consequences of Scottish independence, so by week's end the "No" vote regained a narrow lead in the polls, although it's still too close to call.
Maintaining the status quo would certainly elicit a huge sigh of relief from the currency and bond markets, but would likely mean little for big U.K. equities. As I noted in my Up & Down Wall Street Daily column on Barrons.com last week, the main British exchange-traded fund in the U.S., theiShares MSCI United Kingdom fund (ticker: EWU) isn't terribly British. Indeed, the two classes of Royal Dutch Shell shares (RDS.A, RDS.B ) together constitute nearly 9% of the U.K. ETF, while its single-largest component, HSBC Holdings (HSBC), with a 7% weighting, used to be known as the Hong Kong and Shanghai Banking Corp., with vast operations around the globe, many of them far from the Sceptred Isle.
Beyond the particular interest of Great Britain -- and England, Wales, and Northern Ireland have an interest in whether Scotland secedes even if they have no vote in the matter -- are growing independence movements in the rest of Europe and beyond. Catalonia wants to go its own way from Spain, while Flanders seeks independence from Belgium. That calls into question the notion of a United Europe, especially if the U.K. votes to withdraw from the European Union in 2017.
All of which is a symptom of a broader and more serious trend toward conflicts around the globe that aim to redraw borders that many had thought to be indelible. And not by plebiscite but by brute power. The incursion of Vladimir Putin's Russia to annex Crimea and attempt to build a so-called land bridge through eastern Ukraine threatens a new economic cold war, albeit one using sanctions instead of the ultimate deterrent of Mutually Assured Destruction.
Meanwhile, the atrocities of the Islamic State spurred President Barack Obama last week to assemble a coalition of the kinda, sorta willing. Ten Arab states, including Saudi Arabia, will join in what Obama called a campaign to "degrade, and ultimately, destroy" the Islamic State, although Turkey -- a member of NATO -- declined to permit airstrikes to be launched from within its borders.
This adds up to the tensest global situation since the end of the Cold War, Loomis Sayles' peerless fixed-income manager, Dan Fuss, told colleague Jack Willoughby in last week's Fund of Information column. With the benefit of a half-century of investment experience during that perilous period, the octogenarian retired U.S. Navy officer is trimming the sails of his portfolio and raising cash.
Clearly, the equity and credit markets evince rather less concern. While U.S. stock indexes notched their first weekly loss in six weeks and bond-market yields backed up from their recent lows, the bull markets in both sectors remain intact. Crude oil and gold, two traditional beneficiaries of geopolitical angst, slid further.
The world may be a mess, but the world's central bankers have the palliative in the form of endless free money. The effects are ticked off by Bank of America Merrill Lynch chief investment strategist Michael Hartnett and his colleague Brian Leung: 1.4 billion people around the globe are experiencing negative real (inflation-adjusted) interest rates; 81% of the global equity market capitalization is supported by zero-interest-rate monetary policies; and 45% of all government bonds yield less than 1%.
The eventual removal of this heavily spiked punch bowl is of primary importance to the equity and credit markets that have partied heartily on this hooch. So they will be looking keenly for some clues as to when "last call" will come from the Federal Open Market Committee's meeting this week. The two-day confab will wind up on Wednesday and include the various panel members' projections of where the federal-funds rate target will end in 2015 and 2016 -- the infamous "dots" for their graphical depiction -- as well as a postmeeting press conference with Fed Chair Janet Yellen.
There she should be asked to elucidate the array of indicators the policy makers are using to assess the state of the labor market, which is likely the main focus of Fed policy. On its other main target, inflation, the central bank has gotten a reprieve from a recent easing of price pressures, which should be increasingly visible at the gasoline pump. A gauge tracking real-time prices online from State Street, free of government finagling, also shows inflation rolling over.
The Fed has adopted a series of job-market indicators to augment the traditional unemployment rate, which gets the headlines but is distorted by the widely recognized decline in participation in the labor force by American adults. Employing so many indicators recently led Dallas Fed President Richard Fisher to quote Pimco's Bill Gross in a speech, noting that rather than the two-handed economists derided by President Harry Truman, the Fed was becoming more like a multi-armed Hindu god. Sorry, Dick, that was my quip from my Aug. 25 column, which your speechwriters footnoted but didn't cite correctly.
Words also are likely to be the main points of contention at the FOMC meeting, specifically "considerable time" for maintaining ultralow rates. Economic data, not the calendar, should guide policy, say critics. That would introduce a bit of uncertainty into financial markets, which are beginning to fret that the flow of free money won't last forever.
Whatever the verbiage, the markets are pricing in the fed-funds target to rise from a range of zero to 0.25% (where it has been since the depths of the financial crisis in December 2008), to about 0.25% by next Memorial Day, 0.50% by next Labor Day, and 0.75% by December 2015. The last set of FOMC dots had a median funds target of 1% at the end of 2015, 2.5% at the end of 2016, and 3.75% for a long-run "equilibrium" rate.
Against the backdrop of continued ultralow interest rates, the BofA Merrill strategists note that this week's sixth anniversary of the Lehman bankruptcy will be marked on Wall Street with the initial public offering of Alibaba, potentially the biggest IPO in history. With that, they add, "we have no doubt that hubris is also on the rise." That, despite the perilous world in which these deals are coming. But easy money readily eases such anxieties.
OF THE HUNDREDS OF COLUMNS written by my illustrious predecessor, Alan Abelson, the one he singled out involved a brokerage analyst who was sacked in an act of "unsurpassed spinelessness" for deigning to denigrate the financial prospects of the Trump Taj Mahal in Atlantic City as well as the New Jersey shore resort itself. That was back in 1990.
Last week, Trump Entertainment, which operates the Trump Taj Mahal, filed for bankruptcy protection for the third time, the last being in 2009. The company also owns the Trump Plaza, which will be shuttered this week, and the Trump Taj Mahal, which is slated to close on Nov. 13 if the company can't come to terms on expense cuts with its largest union, according to the bankruptcy filing. If that happens, it would be the fourth of Atlantic City's 12 casinos to shut down.
The result has been a "Detroit-like" socioeconomic picture, writes Triet Nguyen, managing partner of Axios Advisors, an independent research and advisory boutique specializing in high-yield municipal finance. Shrinking employment and a declining tax base raise a bigger question, he writes: "Is Atlantic City heading for default on its outstanding $245 million in [general obligation] debt?"
Debt service and pension contributions absorbed 25% of the city's budget as of fiscal 2013. Nguyen says the tipping point occurs when these expenses "crowd out" other expenditures.
It would seem that Alan was prescient not only about the Trump casino but Atlantic City overall.
THERE ARE PRECIOUS FEW ORIGINAL THINKERS in the investment arena, or elsewhere. Paul Macrae Montgomery, whose unique observations graced these pages over the years, passed away on Sept. 6, too soon at age 72.
Paul, who penned his Universal Economics newsletter out of Newport News, Va., took issue with the shibboleths that markets were run by totally rational players with perfect knowledge to maximize their long-term returns. Markets, Paul asserted, were made up of human beings subject to emotions that could be influenced by all sorts of things outside their understanding or control.
Perhaps his greatest contribution was the tracking of cover stories of Time magazine and their relationship to the financial markets. It seems more than reasonable that by the time a story gets published in the popular press, markets will have largely discounted it. Paul's empirical evidence of magazine covers going all the way back to the 1920s was that the market-related stories appeared just when a wave was about to crest -- and reverse shortly thereafter.
Moreover, Paul was a gentleman, the likes of which is rarely seen anymore. He'd invariably end a call placed to seek his insights by thanking the caller for taking an interest in his work. That's maybe an even greater legacy.

Summary

  • Silver has made a new low.
  • Gold will still likely see a lower low as well.
  • Upcoming week's expectations.
So, how many traders and investors in the metals world are surprised about where we now find ourselves? How many calls for much higher levels have we had to endure before many started to believe that just the opposite was in store?
But, I now hear the "hopeful" amongst you saying to yourself: "but we did not get a lower low in gold yet." Well, the operative word is "yet." And, it will be coming in one of two ways.I cannot tell you how many people told me how foolish I was for expecting lower lows in the metals. I cannot count the number of people who told me that I would lose in a big way on my short positions. The bottom, according to these folks, was supposed to be in last year. We were not supposed to have broken to new lows. Yet, here we are. Silver has now made a lower low, just as expected.
So, over the last few weeks, we have seen raging bulls become "brokenhearted." Yet, some of the same bullish voices calling for higher at the highs in 2011 are still calling for higher, despite making those calls all the way down for the last 3+ years. And, surprisingly, people are still listening because they simply need hope. In fact, too many have been caught buying all the way down, despite the market telling us we should be doing otherwise. There is much pain being felt by investors in this market who have been led astray, and they are now only holding on to hope.
When you invest or trade in metals, you cannot invest or trade based upon "hope." As Franklin once said, "he that lives on hope will die fasting." I wonder if he traded metals?
But, as I have been warning for weeks, while GLD has left me with some questions, silver has been clearly set up quite bearishly. And, this past week, we broke a very important support. We dropped below the 2013 low in silver, which is something I was told over and over would simply not happen. Yet, silver has now confirmed what I have been saying for quite some time: new lows in the metals will be seen.
For now, we have a lower low in silver, and I think levels below this week's lows will still be seen. In fact, don't be surprised by a 15-16 dollar target in silver. But, more interestingly, gold has still not made a lower low, and has held up much better, thus far. Yet, the same issue that I had with silver still bothers me about gold. And, that is that I have no clear evidence of a bottom having been put in for that metal. So, I will still maintain the belief that gold will still likely see lower lows just as silver has.
And, believe it or not, even with that lower low, silver has still not invalidated the potential to head back up to the 22/23 region before the final lows are set in. This same perspective applies to GLD as well, as the lack of a strong break down below 119 has amazingly still left the door open for the move up to the 130-133 region before a run to the final lows is seen.
But, in the most immediate sense, neither metal has shown us any reason to believe yet that those higher levels will be struck before a final low is struck. Rather, as long as silver maintains below 19.33 and GLD maintains below 123, pressure will remain down. It would take a break out over those levels to confirm that GLD is likely heading to the 130-133 region, and silver is heading to the 22/23 region in order to set up the final run to lower lows. Unless we see such a break out, I still expect silver to head down to at least a 16 handle, and GLD to at least the 105 region within the next three months.
So, while I am following this current move down and expecting it to take us to lower lows, as amazing as it may sound to many of you, I still have to keep one eye open to the potential for another fake out rally back to 133GLD and 22/23 in silver, and there are many reasons I have to still entertain this potential. (But, I do want to note that should silver decline below 18.20, it makes the potential for another "fake-out" rally significantly lowered).
A significant portion of the market sees a triangle pattern as completed, and us being on our way to lower lows. Most of the technicians are touting how bad the market looks. Even the fundamentalists are now losing "hope," and some have admittedly become "brokenhearted." Sentiment is at multi-year lows according to some that track it. And, hedge funds have huge short positions in place. This is not usually a recipe for a continued strong decline. So, I am going to be very careful with my short positions, and watch the cited resistance carefully. Should they break, I would not hesitate to bank profits from my short positions (yes, the ones many of you suggested would lose money), and ride long positions to the higher target regions, where I would set up short positions yet again.
My final point is the same point I have been making for quite some time: We have not yet seen the ultimate lows in the metals for this 3+ year correction. The only questions are how and when we get there. And, if we stay below cited resistance, that low should be seen before the end of this calendar year. However, should we break up over resistance one last time, then that lower low will not likely be seen until early in 2015.



HEARD ON THE STREET


Even Zero Debt Would Have Costs for Independent Scotland

Division of Assets, Liabilities Will Determine How Independent Its Policies May Be


Sept. 15, 2014 10:39 a.m. ET

A man walks past a pro-independence poster by the seaside in Aberdeen, northern Scotland on Monday. The referendum on Scottish independence will take place on Thursday when Scotland will vote whether or not to end the 307-year-old union with the rest of the United Kingdom. Reuters
The division of assets and liabilities after a breakup is rarely easy.
But it is this split that will shape Scotland's future in the event of a vote for independence later this week. There are few simple answers. Even the superficially attractive idea for Scotland of walking away from the U.K.'s liabilities comes at a potentially high cost.
Scottish pro-independence politicians have said they envisage taking on a share of U.K. liabilities in exchange for an equitable share of U.K. public-sector assets. But the latter, from Scotland's point of view, includes sterling and a currency union; something that is opposed by all three main political parties in the U.K.
But this division will determine the kind of tax and spending choices an independent Scotland would be able to make. Based on a per capita split, Scotland would take on 8.3% of the U.K.'s debt—implying Scottish gross debt to GDP of 90%, Moody's notes. Another scenario is that Scotland would take on a "historic share" of debt, recognizing past strong fiscal contributions to the U.K. Treasury from Scotland. That would imply a much lower debt ratio—perhaps 45% of GDP, according to Moody's—but would likely be a tough deal to get politically. Both of these outcomes assume, however, that Scotland gets a deal on the currency that proves palatable.
That can't be taken for granted. Any currency union acceptable to the rest of the U.K. would likely involve Scotland ceding back a significant chunk of the independence it has just won, including crucially the ability to set its own fiscal policy. Conversely, a currency union that provides Scotland with fiscal flexibility will almost certainly prove unpalatable to the rest of the U.K.
Pro-independence politicians have said that if the division of assets isn't equitable, in their eyes, then Scotland could refuse to take on its share of the debt. Starting with a clean slate might sound attractive. But it would be a consequence of having to adopt a plan B on currency—already an inferior starting point. It would likely hurt an independent Scotland's credit rating, raising questions over its willingness to pay its obligations and pushing up its borrowing costs.
Moreover, this debt-free solution might be a mirage. Even if Scotland were to emerge with no inherited U.K. debt, it would quickly need to borrow in large amounts to fund its own institutions. Debt would be a minimum of 41% of GDP if Scotland adopted sterling unilaterally and 58% of GDP for a currency peg, UBS estimates, and would likely rise from there. The experience of other countries piggy-backing on another nation's currency suggests Scotland would have to run a tight fiscal policy in any case.
The eurozone, after barely a decade of existence, ultimately saw a breakup as bearing massive costs. Even in that short time, the financial ramifications had become enormous. After 307 years of union, the Scottish case looks even more difficult to unravel.
Write to Richard Barley at richard.barley@wsj.com


What’s on Your Radar Screen?


By John Mauldin 

Sep 14, 2014

Toward the end of every week I begin to ponder what I should write about in the next Thoughts from the Frontline. Much of my week is spent in front of my iPad or computer, consuming as much generally random information as time and the ebb and flow of life will allow. I cannot remember a time in my life after I realized you could read and learn new things that that particular addiction has not been my constant companion.

As I sit down to write each week, I generally turn to the events and themes that most impressed me that week. Reading from a wide variety of sources, I sometimes see patterns that I feel are worthy to call to your attention. I’ve come to see my role in your life as a filter, a connoisseur of ideas and information. I don’t sit down to write with the thought that I need to be particularly brilliant or insightful (which is almighty difficult even for brilliant and insightful people) but that I need to find brilliant and insightful, and hopefully useful, ideas among the hundreds of sources that surface each week. And if I can bring to your attention a pattern, an idea, or thought stream that that helps your investment process, then I’ve done my job.


What’s on Your Radar Screen?

Sometimes I feel like an air traffic controller at “rush hour” at a major international airport. My radar screen is just so full of blinking lights that it is hard to choose what to focus on. We each have our own personal radar screen, focused on things that could make a difference in our lives. The concerns of a real estate investor in California are different from those of a hedge fund trader in London. If you’re an entrepreneur, you’re focused on things that can grow your business; if you are a doctor, you need to keep up with the latest research that will heal your patients; and if you’re a money manager, you need to keep a step ahead of current trends. And while I have a personal radar screen off to the side, my primary, business screen is much larger than most people’s, which is both an advantage and a challenge with its own particular set of problems. (In a physical sense this is also true: I have two 26-inch screens in my of fice. Which typically stay packed with things I’m paying attention to.)

So let’s look at what’s on my radar screen today.
First up (but probably not the most important in the long term), I would have to say, is Scotland. What has not been widely discussed is that the voting age was changed in Scotland just a few years ago. For this election, anyone in Scotland over 16 years old is eligible. Think about that for a second. Have you ever asked 16-year-olds whether they would like to be more free and independent and gotten a “no” answer? They don’t think with their economic brains, or at least most of them don’t. If we can believe the polls, this is going to be a very close election. The winning margin may be determined by whether the “yes” vote can bring out the young generation (especially young males, who are running 90% yes) in greater numbers than the “no” vote can bring out the older folks. Right now it looks as though it will be all about voter turnout.
(I took some time to look through Scottish TV shows on the issue. Talk about your polarizing dilemma. This is clearly on the front burner for almost everyone in Scotland. That’s actually good, as it gets people involved in the political process.)

The “no” coalition is trying to talk logic about what is essentially an emotional issue for many in Scotland. If we’re talking pure economics, from my outside perch I think the choice to keep the union (as in the United Kingdom) intact is a clear, logical choice. But the “no” coalition is making it sound like Scotland could not make it on its own, that it desperately needs England. Not exactly the best way to appeal to national instincts and pride. There are numerous smaller countries that do quite well on their own. Small is not necessarily bad if you are efficient and well run.

However, Scotland would have to raise taxes in order to keep government services at the same level – or else cut government services, not something many people would want.
There is of course the strategy of reducing the corporate tax to match Ireland’s and then competing with Ireland for businesses that want English-speaking, educated workers at lower cost. If that were the only dynamic, Scotland could do quite well.

But that would mean the European Union would have to allow Scotland to join. How does that work when every member country has to approve? The approval process would probably be contingent upon Scotland’s not lowering its corporate tax rates all that much, especially to Irish levels, so that it couldn’t outcompete the rest of Europe. Maybe a compromise on that issue could be reached, or maybe not. But if Scotland were to join the European Union, it would be subject to European Union laws and Brussels regulators. Not an awfully pleasant prospect.

While I think that Scotland would initially have a difficult time making the transition, the Scots could figure it out. The problem is that Scottish independence also changes the dynamic in England, making it much more likely that England would vote to leave the European Union. Then, how would the banks in Scotland be regulated, and who would back them? Markets don’t like uncertainty.

And even if the “no” vote wins, the precedent for allowing a group of citizens in a country within the European Union to vote on whether they want to remain part of their particular country or leave has been set. The Czech Republic and Slovakia have turned out quite well, all things considered. But the independence pressures building in Italy and Spain are something altogether different.

I read where Nomura Securities has told its clients to get out of British pound-based investments until this is over. “Figures from the investment bank Société Générale showing an apparent flight of investors from the UK came as Japan’s biggest bank, Nomura, urged its clients to cut their financial exposure to the UK and warned of a possible collapse in the pound. It described such an outcome as a ‘cataclysmic shock’.” (Source: The London Independent) The good news is that it will be over next Thursday night. One uncertainty will be eliminated, though a “yes” vote would bring a whole new set of uncertainties, as the negotiations are likely to be quite contentious.

One significant snag is, how can Scottish members of the United Kingdom Parliament continue to vote in Parliament if they are leaving the union?

I admit to feeling conflicted about the whole thing, as in general I feel that people ought have a right of self-determination. In this particular case, I’m not quite certain of the logic for independence, though I can understand the emotion. But giving 16-year-olds the right to vote on this issue? Was that really the best way to go about things? Not my call, of course.

Emerging Markets Are Set Up for a Crisis
We could do a whole letter just on emerging markets. The strengthening dollar is creating a problem for many emerging markets, which have enough problems on their own. My radar screen is full of flashing red lights from various emerging markets. Brazil is getting ready to go through an election; their economy is in recession; and inflation is over 6%. There was a time when we would call that stagflation. Plus they lost the World Cup on their home turf to an efficient, well-oiled machine from Germany. The real (the Brazilian currency) is at risk. Will their central bank raise rates in spite of economic weakness if the US dollar rally continues? Obviously, the bank won’t take that action before the election, but if it does so later in the year, it could put a damper on not just Brazil but all of South America. Take a look at this chart of Brazilian consumer price inflation vs. GDP:



Turkey is beginning to soften, with the lira down 6% over the last few months. The South African rand is down 6% since May and down 25% since this time last year. I noted some of the problems with South Africa when I was there early this year. The situation has not improved. They have finally reached an agreement with the unions in the platinum mining industry, which cost workers something like $1 billion in unpaid wages, while the industry lost $2 billion. To add insult to injury, it now appears that a Chinese slowdown may put further pressure on commodity-exporting South Africa. And their trade deficit is just getting worse.

Who’s Competing with Whom?
We could also do a whole letter or two on global trade. The Boston Consulting Group has done a comprehensive study on the top 25 export economies. I admit to being a little surprised at a few of the data points. Let’s look at the chart and then a few comments.



First, notice that Mexico is now cheaper than China. That might explain why Mexico is booming, despite the negative impact of the drug wars going on down there. Further, there is now not that much difference in manufacturing costs between China and the US .

Why not bring that manufacturing home – which is what we are seeing? And especially anything plastic-related, because the shale-gas revolution is giving us an abundance of natural gas liquids such as ethane, propane, and butane, which are changing the cost factors for plastic manufacturers. There is a tidal wave of capital investment in new facilities close to natural gas fields or pipelines. This is also changing the dynamic in Asia, as Asian companies switch to cheaper natural gas for their feedstocks.

(What, you don’t get newsfeeds from the plastic industry? Realizing that I actually do makes me consider whether I need a 12-step program. “Hello, my name is John, and I’m an information addict.”)

Note that Japan is about 10% cheaper than Germany, and those costs are going to drop more as the yen continues to fall. This will affect whether the European Central Bank will finally turn on the monetary spigot to try to produce a little inflation (as opposed to none). In any case, Germany would like to see the euro weakened. Note that Spain, with its aggressive labor reforms, has brought its cost of manufacturing down below that of Germany, to just about the lowest level in Europe. France is the high-cost producer in Europe with the exception of Switzerland, but they don’t do much head-to-head competing. Note, too, that China is no longer the low-cost Asian manufacturer. That’s Indonesia, by far.

O Canada, Where Are You Headed?
My friend Jared Dillian, ex-Wall Street trader and now the editor of a great newsletter humorously titled The Daily DirtNap, has been writing about the problems of Canada for the last several months. Some of it is anecdotal, as in four of the top five major bank CEOs have resigned in the last year, at relatively young ages. Just prior to the Canadian banks getting downgraded by S&P last month. Go figure.

Writes young Jared:

My thoughts: McCaughey is the – not kidding – fourth Canadian bank CEO to retire in the last year. RBC, TD, BNS, and now CIBC. And these guys are not that old. Late fifties, maybe. So it is clear what is going on here – they are cashing out on the highs. It is perfectly rational behavior. Come on – if you were a bank CEO, and you thought that your industry had years of upside left, would you get out? If you were 57? You would not.
The Canadian economy is almost entirely dependent upon its housing market for economic growth. Now, some of my Canadian readers will probably not want to acknowledge that Canadians have an obsession with housing. Debt-to-income levels in Canada are beginning to look a little toppish: $2 million is the new $1 million house. (And in Vancouver it is the half-million-dollar house.) But it has been that way for years. I haven’t written much about Canada lately, because I quite frankly don’t get it. But the country is on my radar screen. Because, I will admit, I really like Canada. At least in the summer.

Thinking about Momentum
Every week I get at least one email from my friend Alexander Ineichen in Zürich. He does this fabulous analysis of scores of momentum indicators all over the world. It’s a good way to get a quick read (well, not that quick, at 90 pages) on what is happening in the real world. Let me give you an example of one of his recent charts:


What I see when I glance through his PowerPoint is that leading indicators are beginning to stall, Eurozone economic sentiment is collapsing, and momentum is not in Germany’s favor. In general, Europe sucks (that is a technical economic term for newbies).

Recently, I’ve become aware of a fabulous young macroeconomic writer from Dubai by the name of Jawad Mian. Remember that name. I read a lot of macro letters, and his is one of the best. Rather than spend the pages that he deserves on his analysis, I just want to acknowledge that he brought to my attention a quote that I’d forgotten from my friend George Friedman of Stratfor. Friedman was responding to a comment by Louis Bacon, who had just returned $2 billion to his investors, complaining, “It is hard to figure out how to invest when actions taken by politicians can affect financial markets more than basic economic factors. The political involvement is so extreme – we have not seen this since the postwar era. What they are doing is trying to thwart natural market outcomes. It is amazing how important the decision-making of one person, Angela Merkel, has become to world markets.”

Friedman objected on the grounds that political decisions are in fact subject to analysis and constraints. He pointed out that Merkel was not acting on whims but on the basis of very real circumstances. Jawad quoted at length from George, but let me pull a few poignant paragraphs that we can all relate to:

The investors’ problem is that they mistake the period between 1991 and 2008 as the norm and keep waiting for it to return. I saw it as a freakish period that could survive only until the next major financial crisis – and there always is one. While the unusual period was under way, political and trade issues subsided under the balm of prosperity. During that time, the internal cycles and shifts of the European financial system operated with minimal external turbulence, and for those schooled in profiting from these financial eddies, it was a good time to trade.

Once the 2008 crisis hit external factors that were always there but quiescent became more overt. The internal workings of the financial system became dependent on external forces. We were in the world of political economy, and the political became like a tidal wave, making the trading cycles and opportunities that traders depended on since 1991 irrelevant. And so, having lost money in 2008, they could never find their footing again. They now lived in a world where Merkel was more important than a sharp trader. Actually, Merkel was not more important than the trader. They were both trapped within constraints about which they could do nothing. But if those constraints were understood, Merkel’s behavior could be predicted.

The real problem for the hedge funds was not that they didn’t understand what they were doing, but the manner in which they had traded in the past simply no longer worked. Even understanding and predicting what political leaders will do is of no value if you insist on a trading model built for a world that no longer exists. What is called high velocity trading, constantly trading on the infinitesimal movements of a calm but predictable environment, doesn’t work during a political tidal wave. And investors of the last generation do not know how to trade in a tidal wave. When we recall the two world wars and the Cold War, we see that this was the norm for the century and that fortunes were made. But the latest generation of investors wants to control risk rather than take advantage of new realities.

We have re-entered an era in which political factors will dominate economic decisions. This has been the norm for a very long time, and traders who wait for the old era to return will be disappointed. Politics can be predicted if you understand the constraints under which a politician such as Merkel acts and don’t believe that it is simply random decisions. But to do that, you have to return to Adam Smith and recall the title of his greatest work, The Wealth of Nations. Note That Smith was writing about nations, about politics and economics – about political economy.

It is getting close to time to hit the send button, and I must confess that this letter became overly long. Simply looking around at what was on my radar screen took me close to 15 pages, and I wasn’t even halfway through! Discretion being the better part of valor, and wishing to take pity on my ever-faithful readers, I simply cut the last half. Perhaps it will show up in some later missive.

But maybe this will give you a little understanding of the angst I go through each week, trying to decide what to write about. In 2006 I was beginning to reach for topics. Today there is literally no end of them.

In deleting half the letter, I left considerable notes on Japan and Europe on the cutting-room floor, as well as concerns about the current brouhaha over secular stagnation. Don’t even get me started on Fed policy and the cult that has developed around central bankers. I would probably start ranting about how monetary policy is about the fourth most important thing but has become an excuse for politicians to do nothing about the more important things that are at least obstensibly under their control.
So what’s on your radar screen?

The Rational Bear

I mentioned last week that my friend Tony Sagami is now publicly working for Mauldin Economics, and we can finally tell you that he has been the brains behind Yield Shark, which is our take on how to find yield in a low-interest-rate environment. Tony ranges all over the world finding those little anomalies which when put together can make a portfolio that generates reasonable yields in a tough investing environment. And every now and then he’s been able to capture some capital gains, which help the overall returns.

You will soon get an important email from Ed D’Agostino, the publisher of Mauldin Economics, telling you about the newest addition to our growing family of letters. Tony and I have been talking about this for some time, and we’ve decided to take advantage of his natural talent and launch a newsletter that will be called The Rational Bear. My good friend David Tice, who ran the successful Prudent Bear fund here in Dallas for so many years (and who lives in the same building I do) has spent a great deal of time with Tony, getting to know how he sees the world, and we agree that Tony has the right philosophy. And with the markets looking a little topping, the timing is not bad.

Just as with Yield Shark, Tony will be our international man. He will look for special situations all over the world that are just screaming “overvalued!” and work out how we go about timing what can be very difficult and sometimes dangerous trades. Shorting stocks is not for beginning investors. Seriously, don’t even think about trying to get your feet wet shorting by subscribing to The Rational Bear. Do your homework about all the risks first, before you start looking at the potential rewards!

With that caution, I think Tony will provide a very valuable service for serious traders. You will have another very astute set of eyes and ears scanning the world to help you with your portfolio research. And frankly, while we don’t talk about it much, we are building up a pretty cool team of researchers that help our writers dig deep and think wide. My partners at Mauldin Economics are handling our expansion, rapid though it is, in a very systematic and businesslike manner. We are all in good hands.

I know that some of you won’t need a letter from Ed to be persuaded to subscribe to The Rational Bear. Here is a link. Note that there is a serious discount off of the subscription price, which will last for only a short time. This is an introductory offer that will go away after launch. Also note that the letter is not cheap. The very nature of the letter means that there is a practical limit to how many subscribers we can have. Again, if you are serious, active investor, this is something you really want to look at. Subscribe now or wait for Ed’s note to tell you more, if you like.

San Antonio, Washington DC, and Dallas
I head to the Casey Research Summit in San Antonio, September 17-21. It actually takes place at a resort in the Hill Country north of San Antonio, which is a fun place to spend a weekend with friends. Then the end of the month will see me traveling to Washington DC for a few days.

I’ll be back in Dallas in time for my 65th birthday on October 4, and then I get to spend another two weeks at home before the travel schedule picks back up. I will make a quick trip to Chicago, then swing back to Athens, Texas, before I head on to Cambridge, Massachusetts, for conferences. There are a few other trips shaping up as well.

Tiffani (my oldest daughter) just sent me a text. It seems she is cleaning out her garage after accumulating a large number of boxes that have gone unopened for many moons. (That trait may be genetic.) I’m not quite sure how she got it, and neither is she, but she came across a paper that I wrote in my first year in seminary, back in 1973, entitled “Poverty and the Poor.” I have absolutely no idea what it says, but I’m looking forward to (and will probably be greatly embarrassed by) reading it. And yes, I went to seminary. I’m a full-fledged master divine or whatever they call the degree holder. I probably needed a 12-step program for that, too, for many years. Fortunately, I seem to have fully recovered. Time heals a multitude of sins, or something like that.

Taking a very full course load while also working a 40-hour week was tough, and it might have affected my academic effort. Evidently the professor who graded this paper thought so, as he or she gave me a B-. Tiffani said the prof wrote in the margin, “You need to do better research.” I’m sure there are lots of readers who concur with my professors. Now, however, my full-time job is research, so I have no excuse. If you give me a B- now, we just have to blame it on sloppy execution.

I’m really looking forward to being with so many friends in San Antonio this coming weekend. It will be my first opportunity to test my new travel resolve, which is to exercise more on the road. Having been home for more than a month and having been in the gym for at least six out of every seven days, I can see and feel a significant difference. It is tough for me to exercise on the road, but I have to figure out how to do it. Maybe I will start holding meetings on the treadmill.

I mean, last time I was in Singapore I had a morning meeting with Jim Rogers. I went to his house and sat outside while he pedaled like a madman on his exercise bike. He would have been about 70 at the time, and there is no way that I could even marginally keep up with him today (or ever!). He went for at least 90 minutes all-out. Outside in the heat and humidity. I was drenched with sweat just watching him. But he held his own in the conversation the entire time. He wasn’t even breathing hard when he got off the bike.

Have a great week and be sure and get a little exercise. You will live a little longer and feel a little better if you do.

Your always trying to think about what to write next analyst,

John Mauldin
John Mauldin