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.
A Day greater than all others this Week
What happened from Monday to Thursday? Do we care? Not really after the horrid Friday. That Non Farm Payroll report stunk up the joint. Rather than read our amateurish words, hear and read what David Rosenberg had to say about this report in clip 1 below. His take on Gold is equally interesting.
What about the stock market? Just look at the statistics. Stocks got taken to the cleaners. After the 100 point drop in the final hour, it felt as if all hope was snuffed out of the optimists on the economy and stock markets. Every one, except of course the “equity fee collectors” (or otherwise known as long only stock managers and stock mutual fund managers), seemed to have given up on the economy. The words “double dip” are now coming readily to the lips of our friendly CNBC Anchors and CNBC Fast Money, that champion of global growth, actually featured a segment about global depression titled The Nightmare Scenario.
If the US employment was not depressing enough, we heard talk of default from the new Hungarian Government. Perhaps the European governments could learn a lesson from the land of Borat. According to the Financial Times, the Land of the Kazakhs (literal meaning of Kazakh-Stan) completed the restructuring of BTA by imposing severe haircuts on investors holding BTA bonds and loans. The creditors of this large Kazakh bank included ABN Amro, Commerzbank, Standard Chartered, ING, DE Shaw and Fortis Investment Management. Can SocGen or Sarkozy spell Kazakh-Stan?
Geo-Events
The week began with Israel’s military intervention to stop the Turkish flotilla. By the end of the week, nobody seemed to remember this incident. We think this event could prove to be long term game changer in the Middle East. For our rather long term and perhaps fanciful thoughts on this topic, see our article Israel & Turkey – Our Views about the Flotilla & Its Ramifications.
Mr. Robert Gates, US Secretary of Defense, was disinvited by China this week. Mr. Gates attributed this to the Chinese Military or the People’s Liberation Army (“PLA”) as it is called. Unlike many China enthusiasts, we believe that China’s Civilian Government can only pursue globalization policies with the consent of the PLA. As long as the money keeps coming in and domestic stability is maintained, the Civilian Government will be allowed to keep its power. But we believe that at the first sign of trouble, the PLA will show all of us who is the Boss in China. This will be a very harsh awakening for emerging market investors. Another reason to support Richard Bernstein’s theme about Developing Markets outperforming Emerging Markets for the next few years. See clip 4 below for the views of a Pentagon Strategist about the PLA.
US Treasuries
After treading water for most of the week, US Treasuries mounted a big rally on Friday with the 30-Year Bond up more than 2 points. This rally fit in perfectly with the fundamentals.
But we were surprised to notice that, according to the CFTC data released on Friday, the net position of Large Speculators in the 30-Year Treasury has now reached a 90% ranking while the net position of the Hedgers/Commercials is now 0%, yes zippo. How quickly does a ferocious rally change positions and views?
For a more simplistic description of our views on Treasuries, see our accompanying article Would Chuck Daly Ask Us To Sell Long Maturity Treasuries?
Currencies
The currency data from CFTC is also interesting. The net position of Large Speculators in the Australian Dollar is 0%, it is 8% in the British Pound and 12% in the Euro. The Australian dollar position is perhaps the best signal of risk aversion by Large Speculators. And this was on Tuesday, two days before the Freeport CEO described China as a “risk” for commodity markets (see clip 3 below).
Featured Videoclips
This week we feature the following viedoclips:
- David Rosenberg on CNBC on Friday, June 4
- Jordan Kotick on CNBC on Thursday, June 3
- Richard Adkerson of Freeport McMoran on Bloomberg on Thursday, June 3
- Bob McGinnis of the Pentagon on CNBC on Thursday, June 3
1. Today’s Market Action – David Rosenberg & Others with CNBC’s Maria Bartiromo – Friday, June 4
David Rosenberg, the Guru at Gluskin Sheff, has been the prescient economist for the past few years. He was proved right again on Friday. His words about the May Non-Farm Payroll report suffice for us:
- Well, what I got out of it (the payroll report) was that the strongest sector of the economy right now is manufacturing, and the best we could do was 29,000 jobs and with the ISM at 60; And that’s the best performing sector of the economy right now; You take a look at state and local governments, they are retrenching, the other sectors, construction and financial services, both negative and those jobs are not coming back. I didn’t know what all the hoopla was about the census hiring related number going into today’s action when you know that employment is a coincident indicator; Jobless Claims are one of the 10 leading indicators in the economy for the Conference Board and we are struck right now on around 460,000 on a 4-week moving average; I mean that is the sort of jobless claims number you had after 9/11 when we were 8 months into a recession and if we sustain these levels on jobless claims, I got news for ya, the second half of the year we are going back into a fraction in terms of those monthly employment numbers….
In a follow up clip titled Markets Fall More Than 3% on Friday, he had more comments.
- Rosenberg – European continent is roughly 20% of Global GDP, it is about as big as the US and we know from the last cycle that we are very interconnected, global economy and capital markets; it is not much say direct impact but indirect impact and the rest of financial contagion, so on and so forth… Basically at Gluskin Sheff we have been anticipating this correction, we have actually been getting our clients in capital preservation themes and long short strategies and into income orientation, and I think we are in a period right now in which we are back to return of capital as opposed to strictly return on capital. Something very interesting that happened today Maria is that copper broke down and gold rallied and that’s something very important here as far as Gold prices are concerned, Gold is increasingly trading less as a commodity and more as a monetary metal and that’s something we are looking at very closely….
- Bartiromo – It is really the mining area that has been among the best performers overall when you look at the last 3 years or so because of the demand coming out of China and SouthEast Asia….
- Rosenberg – right but that’s yesterday’s story; When the Shanghai Index is down almost 30% from the peaks, as we saw a couple of years ago, you don’t want to stand in front of that commodity train; I am a long term commodity bull but I say for the next 6 or 12 months step aside; Gold though is the only interesting variable here because it is not going down to new lows and hanging in extremely well. It is rallying in every other currency except the Dollar. Today it was actually up with the commodity complex down – this is a very powerful story and what it is telling you is Gold is trading higher because it is increasingly behaving as if it is its own currency….it is really consistent with these intensifying investor concerns over the stability of the global monetary system and I got news for you, those concerns are not going to be going away on Monday..no matter how the equity market trades
2. More Trouble Ahead for Europe? – Jordan Kotick with CNBC’s Maria Bartiromo – Thursday, June 3
Jordan Kotick, Global Head of Technical Strategy at Barclays, has been featured in these articles on several occasions. He usually looks at links between different markets and then draws conclusions. In this clip, he began by comparing the graphs of Hungary (did he know Hungary was to going to be newsworthy the very next morning?) during its financial crisis a couple of years ago and the Asian crisis via Dollar-Korea. He then concluded that the European markets are following the Hungarian template.
In response to a question from Guest Host Joe Moglia, Jordan warned that the problems in Europe are not over and investors should be ready for high volatility in the summer. Then Maria Bartiromo asked him “what should the investors do now?”
Rather than answering the question, Jordan Kotick made a statement that sort of chilled us.
- Spain and Italy look like Greece did one month before the blowout; we have Spain taking out not only its ECB highs but its previous highs last week and Spain is now accelerating higher….Two days ago, Maria, we have taken out the highs in Italy, just like Greece before it started to implode. like Portugal before it tried to implode, Spain and Italy despite the package from the ECB, the market is saying we are not finished. That’s instability, that’s a problem
At this point, both Joe Moglia & Maria Bartiromo asked Jordan about the possibility of a Greece-like problem eventually occurring in the US. Jordan replied:
- The market turned its focus on each country, one at a time; it is not a United States problem, we are actually concerned about United Kingdom because if you look at the spreads between Germany and UK, very quietly those have been widening aggressively for the next (?) 12 months.. so next on the horizon has got to be the UK…at this point the market is not worried about the United States
Then Maria Bartiromo asked a key question, “You said this is a correction, not a collapse, what do you mean by that?“. Jordan replied:
- Yes Maria, we think this is a correction of a 15 month move to the topside, what we rather look at finally is US Treasury yields. We are in the strange month of June. 7 of last 7 years Treasury yields have turned the trend in the month of June..you are not going to have yields bottom and prices top out in terms of the Futures markets if stocks haven’t somewhat stabilized; so we think we could go lower in stocks for a month or two, but given how treasury yields tend to turn trend in June, you are not gonna have that without the stock market eventually stabilizing, so keep your finger on the trigger, its going to be dangerous for a month, may be 6-8 weeks but then we think it will be a buying opportunity
3. Freeport’s Adkerson Sees China Risk to Copper Markets – Richard Adkerson with Bloomberg’s Sara Eisen – Thursday, June 3
This is one of the interviews that torpedoed the mining stocks on Thursday. Mr. Adkerson, the CEO of Freeport McMoran, was bullish on the long term outlook for his company for most of the interview. But he dropped a key line in the middle of a rambling answer:
- The confidence (in China) is in the longer term view, China because of its big population and the economic, social, political forces that have been unleashed at least in recent years gives us great confidence about the long term outlook for China. In the near term, it is a risk to the world’s marketplace depending on the events that transpire. (emphasis ours) So from our business standpoint, we are not involved in trading activities, we don’t hedge our production, we make our investments with a long term view and right now we are positive and we are moving forward with our expansion plans aggressively..
This was a tactic that John Chambers of Cisco developed in the technology bear market, to give a long answer about the long term bullish prospects for his company and to slip in a note or two about near term risks. The markets figured it out a few years ago. This is why you often see the markets turn in the middle of the Cisco conference call and begin selling CSCO.
On Thursday, the market ignored all the bullish long term comments by Mr. Adkerson and focused on this key line about China being a near term risk to the world’s metals marketplace. The result was a steep decline in all base metal stocks.
As an editorial aside, this was a poorly conducted interview. It seemed as if the interviewer was reciting a prepared list of questions. There was hardly any give & take that makes an interview interesting.
4. The China Threat & Your Portfolio – Bob McGinnis, a Pentagon Strategist with CNBC’s Erin Burnett – Thursday, June 3
This is another first of its kind interview by Erin Burnett. The trigger for this topic was China’s disinvite to Robert Gates, the US Secretary of Defense. Erin correctly described this disinvitation as a snub to America and opened the question of alarm expressed by Pentagon Strategists about China’s military buildup.
The first portion of this clip is from Erin’s interview last week with the US Ambassador to China, John Huntsman. His comments were revealing:
- ” on the military issue generally, there is a lack of transparency and a lack of dialogue & interaction is a huge problem for the United States and we need more interaction at the junior officer level and we need interaction at the senior officer level and we are getting very little of it right now and when you have no dialogue and when you have no interaction, cultures sort of build up on both sides and they are cultures built upon suspicion and lack of trust”
Pretty straight talk from America’s top China diplomat. Then Erin spoke with Bob McGinnis, retd. Lieutenant-Colonel with the US Army and currently a strategist for the Army at the Pentagon.
- Burnett – What explains the fact that China just won’t tell us the truth and literally it is an issue of not telling the truth – they put out numbers on what they are spending on their military; what $40-50 billion and what I have seen of any real estimates are 4-5 times that
- McGinnis – well, it is 3-4 times that Erin because the People’s Liberation Army has all sorts of side businesses and of course the pay to the average soldier over there is very low. But by and large, for the last 20 years, we have seen double digit increases in their defense budgets and we have seen very tangible evidence of that; they have a new strategic force, they have submarine launched ballistic missiles and they have anti -access weapon systems, in other words, they can stop our carriers and oh by the way, they are making their own carriers, their navy has been described by our Admiral in the Pacific as pretty dramatic increase in capabilities
- Burnett – Is China in any way ready to be a threat to America? They do have the second highest military spending in the world after ours but even if you inflate what they are spending, it is still far shy of the USA.
- McGinnis – Erin, when translate to tangible evidence on the ground, things just don’t make sense; 260 ships. We have 280 and they are ramping up their production of submarines..they have 4 aircraft carriers,… they even intend to build their own aircraft carriers and right now they are training their pilots for those aircraft carriers. This is not a defensive navy; this is an aggressive overseas navy, in fact they recently changed their strategy to what is called the Far Seas Strategy; it is a global strategy.
- Burnett – You think this is an imperialist, an ambitious, externally focused Chinese military, not to defend but to go on the offense?
- McGinnis – certainly very aggressive in the marketplace and because they are very aggressive in the marketplace they have the capability to defend their interests across the globe. So how else do you come to the conclusion that they are somewhat imperialistic?
Good interview but incomplete in our opinion. The second part of this interview should have focused on the following. Gates.
According to the Washington Post, Mr. Gates told reporters there was a clear split between China’s political leaders, whom he said want stronger military ties with Washington, and the People’s Liberation Army, which he said does not – “I think they are reluctant to engage with us on a broad level,” he said. “The PLA is significantly less interested in this relationship than the political leadership of China.”
This is an extremely significant point in our opinion and one of serious relevance to the China investment story. In general, investors believe that the Chinese leadership is a relatively cohesive unit and that the civilian leaders, Hu Jin Tao & Wen Jia Bao are in charge of China. These are leaders that investors have seen and understand.
But what if these civilian leaders are NOT the real power in China? In our opinion, the civilian leadership in China governs at the sufferance of the PLA or China’s People’s Liberation Army. There is absolutely no doubt in our mind that the PLA retains at least a veto power on all major foreign policy decisions and no civilian regime can survive in power if they challenge the PLA on issues that the PLA considers paramount.
The PLA is far more insular and cares much more about China’s Power Projection than the Civilian Government. The PLA does not understand America or other countries the way the Civilian leaders do. The Civilian leaders have been very successful in bringing huge amounts of capital into China, capital that has been used by the PLA to build an globally ambitious military machine. The Civilian leaders have also been successful in maintaining domestic stability. As long as these two trends continue and the PLA is left alone to modernize and expand its machine, the Civilian Authority can continue to govern.
But when these trends reverse and when the PLA feels it needs to exercise its muscle, we think it will and there is nothing China’s civilian leaders can do to prevent it. The fact is that the PLA realized long ago that its ambitions will one day bring it into potential conflict with the American military. They have been planning for such an eventuality for years. This is what Mr. McGinnis meant by anti-access weapons, the weapon systems that can prevent American aircraft carriers or land based aircraft in the Pacific from entering China’s domain.
This scenario chillingly reminds us of the 1930s. The Imperial Japanese Army spent that decade in expanding its military machine to wage war against America if necessary. Once they became confident, Japan decided to expand its reach in the Pacific to seize commodity producing regions and to dominate access to the oceans critical to Japan. They did so by attacking Pearl Harbor and sidelining America for a few months. With that respite, Japan invaded their neighbors in SouthEast Asia.
Next time you read about market conditions today being similar to those in the 1930s, the next time technicians draw chart patterns that resemble the chart patterns of the 1930s, remember that decade long deflation and the Japanese expansion at the end of that decade.
When you hear analysts talk today about the Chinese real estate bubble crashing or deflation spreading through China due to its overcapacity, think of the PLA deciding to invade other countries to seize their markets and resources. This is not our base case of course, but we assign a 25% probability to this event occurring by the end of this decade.
This should have been the topic of the second portion of Erin Burnett’s interview rather than a China stock buyer talking about how US-China are destined to remain friends and how all of us should buy Chinese stocks. Buying Chinese stocks is fine but investors should keep a wary eye on what might lie ahead. US-China relations should not be viewed with complacency or equanimity but with a sense of vigil for the long term problems.
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