Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. Our Web Software does not permit embedding of the clips into our articles. So we shall have to be content to include the links to the actual videoclips. We are very happy with the tremendous response from readers to this series of articles. We thank them sincerely and profusely.
This is an article that expresses our personal opinions about comments made on Television and in Print. It is NOT intended to provide any investment advice of any type whatsoever. No one should base any investing decisions or conclusions based on anything written in or inferred from this article.Investing is a serious matter and all investment decisions should only be taken after a detailed discussion with your investment advisor and should be subject to your objectives,suitability requirements and risk tolerances.
Boring, Grinding, Volatility- Sucking Week
In other words, just the sort of week we saw last fall. These weeks are usually up weeks for stocks and risk assets. Last fall, we discussed these periods at length and the hidden hand of factor-based Quants. This week we saw articles and newsclips discussing the effect of Quant trading tactics and the disappearance of volume. These periods usually end with a bang, the most glaring example of which was the Flash Crash this summer.
On Friday, Seth Merrin, CEO of Liquidnet , said on CNBC that since the flash crash alone, mutual fund investors have pulled out $60 billion from their funds. That, he explained, has resulted in lower trading volumes from his clients, the mutual funds. So the individual investor is trading less, the mutual funds are forced to trade less and the hedge funds have become cautious. No wonder the volume has dropped out of the market. This is why Liquidnet cut about 12% of its staff on Friday.
According to Bloomberg news , fewer than 5.8 billion shares traded on U.S. stock exchanges on Friday, the lowest total of the year. This is far lower than 8.7 billion shares a day in August which itself was 9.5% lower than a year ago.
Can you rely on the market action in such periods? Is the resiliency of the stock markets solely due to the hidden quant bid underneath? What happens when that hidden hand is pulled out, especially as it is during periods of rising volatility? Better not to experience it again. That may be what many investors seem to be thinking these days.
Be a Biologist than a Physicist, says Andrew Lo
Professor Andrew Lo of MIT is a renowned Quant. He was quoted in a Wall Street Journal article as saying “financial markets are better understood through the lenses of a biologist rather than a physicist“. He adds “While Quant managers might like to think that three laws govern 99% of investor behavior and thereby drive securities prices, we are lucky if 99 laws explain even 3% of investor behavior.” This is because physics embodies immutable laws while the biological realm is characterized by adaptation to changing environments.
This excellent article titled Bruised Quant Funds Seek a Human Touch was written by Eleanor Laise of the Wall Street Journal. If this article is correct and Quant Funds lose capital just like Mutual Funds are losing capital, then the search for volume might get even more tough. Unless of course volume explodes as long term investors begin selling their stocks either due to an exogenous shock or simply to take marbles home before taxes rise on January 1.
Richard Ross, a global technical strategist at Auerbach Grayson, told CNBC on Friday that he sees a breakout in stocks coming. He thinks markets in 2010 will follow the 1998 pattern and give us a 8% rally by year-end. He also said next year will be sort of like 1999. Frankly, this seemed very soothing after the terrible forecast by Walter Zimmermann, Chief Technician of United-ICAP, who sees parallels between 1930 & 2010 and predicts that Dow might drop to 6830 (see clip 2 below).
In the Ross case, US Treasuries will fall and their yields will rise. In the Zimmermann case, US Treasuries will rally and their yields will fall.
We can’t wait for the end of October because by then we will know for sure, right?
Geo-Strategic Tensions in EM
This is the one bull market you can count on. We might be biased because it is our own tune. But we see more and more signs that support our view. We also see more and more mainstream journalists getting on our bandwagon.
Today is September 11, the 9-year anniversary of that awful day in 2001. Perhaps it is fitting that Af-Pak is again on a boil. On Friday, Karin Brulliard of the Washington Post wrote a detailed article titled Flooding deepens age-old fissures in Pakistan . This is a completely different tune from the previous articles in the Wash.Post about Pakistan. Read the first sentence of the 3rd paragraph “Pakistan’s four provinces, which have long battled each other for resources and influence, are engaging in cutthroat battles for shares of flood aid money.”
This explosion of nationalist sentiment does not come as a surprise to us. We had discussed this in our own article “Are you from the Pakistani army or the Sindh army?” – This quote from the New York Times Shook us .
While a revolt in Pakistan and a potential conflict with India is serious in itself, that is not what worries us. This week, the geopolitical world was shaken by a New York Times Op-ed piece about the geo-political crisis unfolding in Baltistan. You have never heard of Baltistan? Perhaps, you know it by its capital, Gilgit. No? Then you should resign from your Emerging Markets job. Just kidding.
Baltistan is an extremely strategic province of Kashmir that is occupied by Pakistan, claimed as its integral part by India and desired by China. Baltistan borders Xinjiang province of China to the North, Afghanistan to the west, India to the south east and Pashtunistan, the Pashtun territory occupied by Pakistan to the south west.
We have believed for some time that Pakistan would cede this province to China and that will set off a geo-political crisis. We felt this would come to a head after US Forces leave Afghanistan. Well, according to Harrison, Pakistan has already ceded Baltistan to China . The Chinese foray into Baltistan was the principal topic in the discussions between Admiral Robert Willard, US Pacific Command Chief, and Indian Military Command in Delhi this week. In its comments on this topic, a Stratfor analyst said that the PLA (Chinese Military) is getting more vocal and involved in Chinese policy, a stand we have taken for some time.
China and India share a very long border thanks to China’s annexation of Tibet in 1950s. This entire border is subject to claims and counterclaims. India will have deployed Nuclear missiles to hit every city in China by 2015. China can hit every city in India today from its nuclear missile bases in Tibet. China has built up a massive infrastructure along the entire border. India is now trying to catch up.
The big race is whether China reduces its military gap with the United States BEFORE India reduces its military gap with China. Many experts believe that China will create a military conflict with India within the next 3-5 years before India can build up its military infrastructure on the border. This conflict can start with a military incident between India & Pakistan in which China ends up as a participant.
China is on an aggressive mission to get control of mineral resources wherever it can. India is its sole challenger to the mineral resources of Afghanistan and Central Asia. The geographical key to such resource control is Baltistan. Through a rail link from Kashgar in Xinjiang to Gilgit in Baltistan and the connections to Pakistan’s rail network, raw materials can be sent from Xinjiang to Gwadar, at the tip of the Straits of Hormuz in 48 hours.
Need we say more? Does this remind you of the 1930s and Japan? How do you hedge your EM portfolios against this tail risk?
Note: For a more detailed discussion of this story, read our article Baltistan – Where the Word Meets for the Next Geo-Crisis.
- James Bullard on CNBC Closing Bell on Thursday, September 9
- Walter Zimmermann on CNBC Closing Bell on Thursday, September 9
- Nouriel Roubini on CNBC Closing Bell on Thursday, September 9
- Jonathan Litt on CNBC StreetSigns on Friday, September 10
- Richard LeFrak on CNBC Squawk Box on Friday, September 10
1. James Bullard with CNBC’s Maria Bartiromo – Thursday, September 9
James Bullard, President of the St. Louis Fed, has become an important spokesman for the Bernanke Fed. Since we think monetary policy drives markets, we have no choice but to give the Bullard clips our pole position this week. This interview is in two clips:
Read a summary of his views at Economy to Slow Further but Rebound Next Year on cnbc.com. A couple of excerpts are below:
- The consensus is developing in the forecast community that we’ve got a slower economy in second half of this year,..But we will pick up in 2011, probably back to trend growth, or even better.
- He reiterated the Fed’s recent statement that the central bank will take further steps to boost the economy if growth continues to worsen.
- I don’t think it’s a good idea to raise any taxes ..when you’re trying to get a recovery going.
Frankly, we think a better article on Bullard’s views is Fed Ready for Further Action if Necessary on WSJ.com. A few excerpts are below:
- I think the FOMC did make a move to position itself to be able to act if necessary, to take more action, more easing type action…The purchase of longer-dated Treasurys is the most promising action we can take.”
- I think we have to be prepared to move, and I think the committee is much closer to being prepared than we were, say in June, or May of this year,…” Bullard said, although he added, “I don’t think it will be necessary to take additional action.
- Bullard also noted large countries with very low interest rates and weak pricing environments, like the U.S., Japan, Europe and potentially the U.K., cannot use their exchange rates to boost inflation away from deflationary levels. He said such an action “might not be prudent, and it might not be possible.”
- He also suggested a renewed vigilance on a threshold that, if crossed, would cause the Fed to act. Referring to the annualized gains in core consumer prices of around 1%, Bullard said, “That’s not extremely low. But if it would start to go down from there, to 50 basis points or down to zero, then I would start to get concerned we’d be in a Japanese style scenario, so I think we want to defend our inflation target on the low side, and take aggressive action if necessary.”
- The Fed president also said the US government needs to create more certainty so businesses understand what’s ahead in tax increases, healthcare costs and financial regulation.
- I don’t think it’s a good idea to raise any taxes,” he added, “when you’re trying to get a recovery going.
- In other comments, Bullard said the Fed takes a cautious approach when it comes to the stock market. “It’s a losing game, I think, to try to influence the stock market,” he said, adding, “I don’t” think we try to worry too much about particular stock market movements over any short length of time.”
2. Charting the Future – Walter Zimmermann with CNBC’s Maria Bartiromo – Thursday, September 9
Between the above two clips of James Bullard spoke Walter Zimmermann, the Chief Technical Analyst of United-ICAP. This is a follow-up to the interview by Walter Zimmermann on Tuesday, August 10 in which he had discussed similarities between the stock markets of 2010 and of 1930 (see clip 4 of our August 8 – August 14 Videoclips article).
In her opening comments, Maria Bartiromo described the concept briefly: “Stocks peaked in 1929, then they fell 50% only to rebound by 54%. But the important thing to watch here is the crash that followed the rebound, a 90% decline. Compare that to today’s market. The Dow peaked in 2007, followed by a 54% decline. Then we got a rebound of 62%. And now we are seeing stocks fall. Why does this matter? My next guest says we have a long way to go on the downside.”
With these words, Maria introduced Walter Zimmermann:
- Bartiromo – Walter…a month ago you said, stocks were declining at a lot slower than they did during the great depression. Now you are saying that the pace has picked up and we are going to see that decline sooner rather than later. What happened?
- Zimmermann – Well, I think what happened was there was a recognition here that things weren’t really getting better and that dawning recognition is now reflected in the stock market. So now, week by week, day by day, the parallels between 1930 and this year 2010 have grown even more dramatically to the point where now (chart is displayed on screen) so far we have been tracking every turn that occurred in 1930 with just a few weeks delay. Now if we project that out to say OK, if these parallels continue what does the future bring? It suggests that from here, we will continue to slowly grind higher back up towards 1000 (does he mean to say Dow 11000?) by mid to late October, and then from there if we get the same percent decline as we did from fall to winter of 1930, that would return the Dow to the lows we saw back in March 2009.
- Bartiromo – So, you are expecting a sharp decline in October, that is the bottom line. What are the groups that are going to lead this? How significant might this decline be?
- Zimmermann – Well, as far as leading groups, we have never seen such a high correlation across market sectors as we see right now. Its almost unprecedented, all the sectors are moving together. Not just the sectors within the equities, but commodities are now locked in as well. So it doesn’t look like there is going to be a whole lot of ability to diversify against this. When this goes, everything is going to go.
- Bartiromo – Size of the decline? what are you talking about? 50%, 30%?
- Zimmermann – Well, we are talking about Dow basically falling from 11,000 area to the 6,800 area sometimes in October to perhaps by early January, that what we see as the risk. Continuing with parallels with the 1930. And of course, there are other indications of that. There is plenty of bad news to go around.
- Bartiromo – Walter, I am sorry you are the bearer of doom today….I am hearing a lot of bad news between you and Nouriel Roubini.
Speaking of Nouriel Roubini, listen to him next.
3. Roubini on the Economy – Nouriel Roubini with CNBC’s Maria Bartiromo – Thursday, September 9
What would you expect Signor Roubini to say? Exactly! Read a summary of his views at Growth to Halt in Second Half, Payroll-Tax Cut Needed on cnbc.com. If the title is not clear enough, read a couple of the excerpts below:
- “It will be a vicious circle because the economy is going to surprise to the downside…The stock market is going to correct, credit spreads are going to widen. It will be a negative effect on consumption investment, the cost of capital is going to rise. And then you have another shock to the real economy, ending in a vicious cycle in which you can go off a cliff.”
- “That’s already a growth recession,…The second half of the year is going to be worse than the first because all of the tailwinds to growth become headwinds.“
Roubini said third-quarter GDP is likely to be closer to 1.0 percent than the 2.5 percent that the consensus is predicting. Then he called for a Payroll Tax cut financed by taxes on wealthy Americans.
4. Best Global Land Plays – Jonathan Litt with CNBC’s Erin Burnett (04:31 minute clip) – Friday, September 10
Jonathan Litt, Principal of Land and Buildings, is a hedge fund manager. He used to be a respected REIT analyst on the Street. As Erin Burnett says in her opening comments, Asian Real Estate is one of his biggest bets.
- Burnett – You liked Japanese Real Estate before the stimulus package was announced. Now they have announced another 11 billion dollar one. Why Japan? Whenever we hear Japan, we always hear about Deflation and an economy that won’t grow?
- Litt – When we looked at Japan over the past 2 months, it is coming under an enormous amount of pressure as its currency has strengthened…Typically when we get into these periods, we see the Govt. coming out with monetary and fiscal stimulus plans. What we were looking at on the property side was a company that trades now at about 25% discount to where we see the underlying real estate trading in that market,..Mitsubishi Estate, we said this is too cheap, eventually the Govt is going to do something to try to respond and when that happens, that gap is going to close.
- Burnett – Staying in Asia, where your love affair is today, you like Australia, how come?
- Litt – As we look around the world, the US has outperformed quite a bit in terms of property stocks and we look what’s underperformed, where do we see values? Where do we see opportunities? Where do we see good growth prospects? And Australia has good growth prospects, the economy is growing, they are natural resource based, …and in the office market in Australia, we started zeroing in on a name which was trading at a nice discount, the currency is strong, rents are going in the right direction, leasing is going in the right direction and so we focused on a company called Dexus Property, which is principally an office company in Sydney and Melbourne, and …it is trading ar probably 25% discount to underlying asset value…………
- Burnett – Now lets talk about China….you have a long and a short linked to China.
- Litt – We think…..the best long opportunity is Hong Kong Land….. They own prime office in central business district of Hong Kong. The vacancy rate is about 1%, so basically there is no availability. There is virtually no new construction coming on. China is still growing….Rents will likely be up this year 25% in the Chinese office market. The leases are only 3 years in duration. So you are gonna get a lot of that rent growth to your bottom line fairly quickly. And the stock is trading at a discount to where you believe its NAV is, again in that 20-25% range. So the stock will continue to do well and it is probably the best names among the stocks we talked today on the long side.
- Burnett – In a nutshell, you get out of Guangzhow (?)
- Litt – yeah, the home building market is China is in the bulls-eye of the Govt trying to cool the economy, they don’t like the price increases because they want people to be able to buy homes, and Guangzhow with a bad balance sheet is at the high end of the market where a lot of speculation has occurred and is at the most risk of downside we think from here.
5. LeFrak’s Economic Outlook – Richard LeFrak on CNBC Squawk Box – Friday, September 10
Richard LeFrak, President of the LeFrak organization, is one of best voices for real estate. This interview shows why. His other clip of the morning is titled LeFrak’s Expanding Empire .
Read a summary of his views at Still Waiting for Real Estate Shoe to Drop on cnbc.com. A couple of excerpts are below:
- The danger of a collapse in the commercial real estate sector seems to have been overcome due to he low interest rates, but investors are still waiting for the second shoe to drop in the downturn.
- So what happened is that interest rates are so low, that some real estate is actually inflating pretty hard now,…And it’s all because they kept rates down so low that a lot of the day of reckoning just never happened. So we’re all waiting for it.
- I deal with consumers at an interesting level – I rent apartments to them,…In certain markets, they’re doing very well. There’s been very much an increase in the market for rental apartments.” New York, Florida and the West coast are areas where rents are doing well, he said.
- In the business community I think it’s pretty common knowledge right now that this coming election is going to have a lot to do with people’s attitudes, not necessarily about the economy but about the future,
- Lowering taxes is one way of boosting economic growth, according to LeFrak.
- You can’t say on one hand ‘hey we’re going to raise your taxes’ but then ‘you have to hire people,
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