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.