Ben Bernanke in The Daily Show about quantitative easing

I just love Jon Stewart

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World Energy Outlook: Prices will rise, dampening growth

As of  November 9th, 2010, the World Energy Outlook 2010 was released by the IEA. Some charts of the press presentation are really worrysome:

1. Conventional oil production has already peaked 2006. Conventional oil  can be pumped out of the ground cheaply and easily. Unconventional oil is extracted from oil sands or from deep water oil fields; production costs are high.
   
   To maintain todays production levels in the next decades, crude oil fields have to be developed on a big scale. Personally, I am scratching my head, wondering whrere we will find those oil fields. Remember, that the we are not talking about the hard to develop unconventional oil, its share is small.
   
   
2.  The next chart is about energy consumption. While the IEA correctly assumes that emerging economies will consume more oil and coal...
   ... it assumes that the developed countries are willing to reduce their oil and gas consumption significantly. So, please sell your Porsche or your Range Rover. China needs it all, sorry!
   
   
3. Hence, we can safely assume that belows oil increases are an understatement.
   

It seems evident, that the IEA is downplaying future oil price hikes. Follow this blog to read more about the IEA report.

Bottom line, those higher energy costs will damp future growth significantly!

European Sovereign Debt Crisis

Marktets have been weak today, partially because of the European sovereign debt crisis caused by Ireland's banks: Today's Financial Times has a nice graphs giving you an idea of the size of the problem:

Germany is in a real dilemma: Since its banks are loaded with Irish bank debt, banks will lobby hard for government protection, while hard working citizen will loath paying for it.

I have also found a Morgan Stanley Report as of November 22, 2010 (Morgan Stanley Strategy Forum) going into the details of the crisis:

Global Economics by Joachim Fels:

"The support package for Ireland that was agreed in principle last night won’t mark the end of the European sovereign debt crisis; it just opens a new chapter. Our view all along had been that Greece was only the beginning and that the sovereign debt crisis would work its way through the periphery and eventually into the core of Europe. Also, when the big European rescue fund, the EFSF, was created in the spring, we said that governments’ hopes that it would never be used would be disappointed. Last night, the European finance ministers decided to activate the fund."

 Moreover he mentions 3 uncertainties:

1. The European help for Ireland will increase the banks' solvency but the ability to repay the Irish government debt is still in doubt.
2. What happens when the rescue fund expires in 3 years? Should bond holders contribute as well? This would downgrade government bonds!
3. The rescue fund is importing the debt crisis from peripheral Europe to core Europe (core Europe is guaranteeing  debts of peripheral Europe).

What if I had bought Apple stock instead...

Blogger Kyle Conroy researched prices of Apple products and stock prices. He came up with a interesting table which gives you the value of your Apple stocks if you had invested the money in Apple stocks instead of buying an Apple product:

I

Instead of buying a PowerBook G3 in 1997 for USD 5700.- you would have Apple stocks (AAPL) worth USD 330.000.-. The reason for this staggering investment performance is of course AAPL stellar increase from USD 4. to USD 300.-:

Source: Reuters

In hindsight, we all know better.

Taleb: The Fed is squeezing the ketchup bottle of inflation until we are all covered

Nassim Taleb author of "Fooled by Randomness" and "The Black Swan" and succesfull options trader is a outspoken critic of the financial establishment. He is focussed on non-linear relationship and improbable events which are occuring in financial markets far too often. Recently, he discussed the Fed policy on Bloomberg TV and made pitroesque comparison with a ketchup bottle:

Outperformance of Low Risk / Value Stocks

Last week I have attended a interesting presentation by Prof. Haugen organised by the Swiss CFA Society.
 Mr Haugen made very convincing case for low risk value stocks. These are stable stocks with a sound business which generates nice but stable (not fast growing stocks) stocks with attractive dividends reasonably priced. His empirical research proved that these stocks are outperforming the market consistently over the last 80 years.

His explanation in his 2008 paper "Case Closed":
..."we feel that the market overreacts to past record of success and failure on the part of companies, making relatively expensive (growth) stocks too expensive and relatively cheap (value) stocks too inexpensive. After the initial overreaction, the market tends to correct itself, producing low returns to expensive growth stocks and high returns to cheap value stocks, as the relative profitability of these companies tends to mean-revert faster than expected."

This paper has very important implications for stock selection, and provides the empirical evidence for the successful value approach of Warren Buffet.

Quantitative Easing for Kids

At a presentation of Morgan Stanley, we were informed about a very educational movie. Enjoy!

US Monatery Base

The monetary base is the amount of money in the economy and consists of coins, paper money, and commercial banks' reserves with the central bank. This base is the only thing a central bank can control directly.

I have plotted a historic graph of the monetary base below. The base shot up like a rocket in the last two years. The Fed must be desperate to employ such an unprecedent measure.

Please keep in mind that the USD 600 billions of QE2 are not included (it would not even fit in)!

Chinas Property Market and High Risk Rally

BCA’s Arthur Budaghyan made in a presentation following keypoints about Chinas property market and its influence on emerging markets equity: 

In the last two years, the global recovery was driven by government stimulation of Chinese housing/construction. Properties rallied additional 45% in the12 year old bull marked. The Chinese government seems now to be concerned and increased interest rates to stop the overheating property market. Last time the Chinese government increased interest rates (end of 2007), commodities and emerging markets tanked 6 months later (usual time lag of monetary policy). Arthur thinks QE2 ignites only a short rally and in 3 months a bear market will start hitting emerging markets hard. 

Other indicators of a market peak are increased IPO activity by commodity traders (commodities and Emerging Markets correlate highly) such as Glencore (remember Goldman Sachs IPO was in 1999 and Blackstone in 2007).

Moreover, trading volume in emerging markets went ballistic because of  indiscriminate purchases and massive capital inflows. 

Also, in the last months commodities rallied in USD terms but not in CHF or JPY termsf (defensive currencies). The former is a sign of USD weakness and the latter of a non-confirmation of sustained emerging market performance.

Hence, the prefered asset class is cash. Arthur is also not negative on the USD since he believes that QE2 will not feed into the real economy which would be consistent with a deflationary scenario

Greek Swap File

Bloomberg has reported that the ECB is not going to disclose a report of Greeks' swap transaction with Goldman Sachs. The Bank helped Greece to access the EU by selling them dubious swap transactions which hid the countries debts and deficit.
ECB's Monsieur Trichet has been quoted: “The information contained in the two documents would undermine the public confidence as regards the effective conduct of economic policy...” and “... in the current very vulnerable market environment, the substantial and acute risk of adding to volatility and instability.”

Needless to say that this swap has damaged the Europes citizen.
 Anyone Euros or Greek bonds?

Barton Biggs and Bill Fleckenstein on Bloomberg TV

On the blog Dealbreaker.com I stumbled over a funny interview. The cluelessnes of anchor Betty Liu is especially entertaining, although Barton Biggs is not convincing.

The Suicide of Wall Street

I have to admit, I am ordinary: My  favorite author is bestseller writer Michael Lewis with his two books "Liar's Poker" and "The Big Short". For those who did not read them let me give you a brief introduction:

• "Liar's Poker" is about the life inside investment banks at Wall Street in the eighties. It shocks reader with their surreal culture of greed. However, the stories told in the book are very funny and entertaining.
• "The Big Short: Inside the Doomsday Machine" tells the story of a few outsiders of Wall Street betting against the system and winning big. The greed of Wall Street managed to increase dramatically: bond traders complain even when they earn a USD 47 million bonus today.

In a Bloomberg TV on YouTube Michael Lewis states that Wall Street business model might cease to exist once the anger of the electorate finds its way into politics. Let us pray!

Today investment banks act as intermediary for their clients, but in the same time they try to make a quick profit by trading against their clients, which creates big conflicts of interests. Maybe in the future business is divided into brokers like Charles Schwab and hedge funds doing the trading.

By the way, another funny, shocking, and entertaining movie is "Enron: The Smartest Guys in the Room" , although it is to celebrating its fifth anniversary. See the trailer:




For readers who are interested in manias, bubbles and the like I can recommend "Extraordinary Popular Delusions and the Madness of Crowds". You get roughly 400 years of financial madness.

Chinese Debt and Overcapacity

In the last post I wrote about Chinese excess of debt. Since I was not entirely convinced about the argument I have tried to dig deeper. Morgan Stanley's Qing Wang wrote extensively on March 31st, 2010 about this issue:

He maintains, that China's overall debt level is at 170% of GDP in comparison to the debt level of 250%-500% for developed countries.Moreover, he thinks external debts are more significant "because domestic debt can be offset by domestic assets". And "measured by external debt, China's indebtness is one of the lowest in the world". The author goes on comparing debts to assets, cash flows etc. and sees no systemic risks. However, intransparancy of non-performing loans of some local banks is weighing on their stock prices.

As for capacity, it is apparent that there is overcapacity in real estate and some industries. However, I doubt that these sectors can drag down the whole economy substantially. Furthermore, the introduced interest hikes should damp the growth of capacity.


On October 22, 2010 in Morgan Stanley's Global Executive Brief Gregory Peters and Jason Draho summarize the situation: "With QE supporting a risk-on sentiment, we would: (1) sell USD; (2) go long equities, maintaining a preference for EM over DM".

It's again: Don't fight Fed

China Overcapacity vs. Don't Fight the Fed

In the last couple of days I have read a interview on Businessinsider.com and saw a slideshow of Vitaliy Katsenelson. Although Vitaly could brush his presentation to look more professsional, I give him big credit for making me think about China's investment case:

• Overcapacity: Due to its partially centrally managed economy (with its huge buraucracy), over capacity has been built up mainly in real estate (residential and commercial) and in heavy industries such as cement and steel. The stimulus program to dampen the effect of the crisis in 2008 is increasing capacity as well.
• Too much debt: Huge amounts of money (loans) is handed out according political consideration especially on local level. The stimulus package will increase bad loans. 
• Effect on Chinese economy: Due to high fix costs the Chinese economy will tank because of high fix costs (capacity and cost of debts).
• Effect on other economies: Commodity exporters such as Australia, Brazil, and Russia will have a hard time.

But, don't fight the Fed. Although the picture drawn is dark, we have a quantitative easing program in the US, which will generally support asset prices big time. So, in the short run I do not think this bubble will burst.
Of course, this strategy can bring you in a tight spot once the bursting is earlier than you anticipated.

Inflation and Stock Returns

Investors who think they can protect themselves against inflation by buying stocks instead of bonds  will be disappointed by www.businessinder.com's chart:

Although, seasoned and old fashioned value investors who follow Benjamin Graham's principle (like Mr. Buffet) already know those facts.

Monetary Policy: Inflation

Today's Financial Times features an important article about inflation in the US. Investors are expecting inflation to be higher in the longterm. The graph on the leftern side is exhibiting the implied inflation rates of bonds maturing in 10 years.

On the rightern side you see the increasing yield of 30 year bonds. Apparently investors believe that the Fed will have problems to control inflation caused by the renewal of the quantitative easing program (so called QE2).

Monetary Policy

The most sound analysis I have heard this week was a short interview with Stephen Roach on CNBC
(http://www.businessinsider.com/stephen-roach-quantitative-easing-2010-10).

He basically said

1. Global  imbalances: To hold China accountable for the imbalances (due to their yuan-dollar peg) is nonsense,  because USA is consuming too much and hence buying too much from China and 89 other countries with which the USA has a trade deficit. So people ought to save more in the US and spend more in the other 90 countries (inluding China).
2. QE (Quantitative Easing: Fed buying securities) is only creating hot money searching for hot investments. It is not going to help the economy, because indebted American families save for their retirement, which is the right thing to do.

In a nutshell, the talk about devaluation is chatter of politicians in reelection and QE is creating only hot money in search for hot investements!

Asset Allocation / Emerging Markets

Last week BCA Research (renowned, independent research from Canada) published the October Bank Credit Analyst. Their core statements are:

•  Despite the headwinds posed by the fading of the inventory cycle and fiscal stimulus, the U.S. will avoid a double-dip recession.

• The anticipation of a new round of quantitative easing has pushed down real interest rates. However, evidence of a “bond bubble” is lacking.

•  A widening of spreads among peripheral economies in Europe at a time when risk assets have rallied is troubling, but ultimately Europe will avoid a fiscal crisis.

• Equities should be able to grind higher despite a sluggish growth outlook on the back of extremely accommodative monetary policy and reasonably firm profit margins.

•  While EM equities should continue to outperform thanks to continued capital inflows, on a valuation basis, emerging market equities are no longer cheap relative to developed markets.

The chart demonstrates the outperformance of emerging markets for the past 2 years:

A recent investor’s survey by Morgan Stanley confirms the preference for emerging markets:

 

Momentum investors will try to profit from the current movement while value investors will underweight emerging market stocks.