Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. 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.
The Other Shoe Falls
Last week, the reality of the US Economy crashed into the perception of strong self-sustaining growth for the rest of the year. The Jobless Claims also came in weaker this Thursday. But no one cared on Thursday because of optimism about China’s GDP rising by 9%. Thursday was a big risk-on day with the Dow rallying by 181 points. Metals, Financials and Technology all roared.
China’s GDP growth did surprise but on the downside. It came in at 8.1%, down from 8.9% in Q4 2011. The Dow fell by 137 points. And Metals, Technology and Financials all cratered. That was not just because of China. So-so earnings from Google & JP Morgan didn’t help.
What’s happening in China is extremely important to global markets. And we just don’t mean the Bo Xi Lai saga, though that is really interesting and potentially critical to China’s leadership transition. What’s happening to the economy is much more relevant in the near term. This week, we heard from three investors with extensive China expertise or experience:
- Mark Mobius (clip 2 below) – China is looking at 7.5%. That’s their target. They may not reach that target. It may be more than that. They are having difficulty slowing down the economy.
- Jim Chanos (clip 4 below) – If they say growth is going to be 8%, I can assure you it’s going to be 8% or 8.1 or 8.2…But the reality is in all things we are looking at, the property sales, cement prices, steel crisis, power consumption – it appears it’s slowing faster
- Donald Straszheim (clip 3 below) – I think it’s [China’s growth] going to be more flat. in fact, lower second quarter than first quarter. And the reason is that China’s problems are not primarily cyclical, they are much more secular, structural and you don’t fix those problems in a month or a week or a quarter….I think the export problem is a bigger problem for China than is the housing. It’s going to get fixed. but China is not as competitive as it used to be in terms of exports. Japan, America, Europe, three big developed markets for China’s exports — they’re not terrible, but they’re not great and China’s trade surplus is already coming down and it’s going to go down more.
Gary Shilling reiterated his “hard landing” scenario for China (see clip 1 below). Andy Busch of BMO Capital was explicitly negative:
- They can’t control the downward motion in their economy…
2. The real Other Shoe!
Though we feature China-related clips this week, the real other shoe is Europe. And it began falling faster this week. This time it is Spain. Just 3-4 months ago, the Euro-Troika poured in the equivalent of French GDP to stabilize Europe financially. Now it seems to be coming apart again. We will see what happens next Thursday, when they auction off the Spanish 10-year. That auction may go well if only because the ECB goes in and buys as indicated by Benoit Coeure, an ECB executive board member.
But that band-aid may not last because the underlying economy in Spain seems to be falling faster than was expected, or “another Greece” as Rebecca Patterson of JP Morgan put it on CNBC Money in Motion on Friday. Her colleague Andy Busch said of the Spanish budget, “basically, it is pretty much a disaster“. Sean Egan of ratings firm Egan-Jones was pretty clear in his comments on the same Money in Motion show:
- Egan – … we think Italy, Spain and Portugal are going to be under a lot of pressure and we don’t think it is going to look very pretty in the upcoming auction…..
- Busch – do you something like Greece development in Spain? They have like 22-23% unemployment. It looks like it is ready to go this summer.
- Egan – Absolutely. Bear in mind, most revolts happen in July. Think of Bastille day, think of July 4th. Think of the Arab spring. It is much warmer in the Arab countries in the spring. So this summer is going to be very interesting…when people can’t pay for food, they are going to go to the streets, when unemployment in the area of 23% in Spain, you are going to see a lot of people protesting.
- Egan – … the banks and governments in southern EU are linked, are joined at the hip and both of them are weak, so we expect a number of downgrades in the next couple of months..
So the US Economy is the only major economy looking somewhat OK. That is why last week’s Non-Farm Payroll number was such a shocker to the markets.
3. U.S. Stock Market and U.S. Treasuries
The most succinct expression of the past couple of weeks came was tweeted by Keith McCullough of HedgeEye on Friday:
- People who told you to short Treasuries and buy Equities in mid-late March need a ……
The 10-Year Treasury note closed at 1.99%, a hair below 2%. Jeff Kilburg of Treasurycurve.com, the stalwart and committed bull, reiterated his 1.67% target for the 10-Year Yield. Gary Shilling of course has a lower target of 1.5% for the 10-year yield and 2.5% for the 30-year yield. The 30-Year Treasury yield close on Friday at 3.13%. So 2.5% would mean a juicy capital gain indeed.
Lawrence McMillan of Option Strategist wrote on Friday morning:
- The violation of the 1390 support level this week turned the $SPX chart negative. something quite serious, but it if holds, that would be bullish….. The heavy selling early this week pushed breadth indicators to an extreme oversold condition. They are now on buy signals….The recent two-day rally is just a pullback to the resistance area at 1390. Any further rally will need to be based on more than an oversold condition. An $SPX close above 1400 would be bullish.
Next week should be an interesting week, with earnings from major bell-weathers like Goldman Sachs, IBM, Intel, Coca Cola, GE, Schlumberger, to name a few. Sometimes, a stock market that is weak going into major earnings can rally steeply upon positive earnings surprises from such bell-weathers, especially during an options expiration week. Add to that a better than expected Spanish auction on Thursday and we could see some fireworks next week.
4. Emerging Markets & Fund Flows
Mark Mobius of Templeton Emerging Markets group is as bullish on emerging markets as ever. His best candidate is Russia, followed by China (see clip 2 below). Could he be right? Will investors fly from Europe, US and possibly China into smaller emerging markets?
Michael Hartnett of BAC-Merrill Lynch doesn’t see that. In his report titled A Week of Risk Capitulation, Mr. Hartnett wrote:
- Biggest outflows of 2012 for equities and commodities; first outflows of 2012 for High Yield and EM debt funds….In contrast, inflows to Treasuries (largest since August 2011) and Investment Grade bonds…
- EM equities see biggest outflows ($0.9bn) since Dec’11 (dragged down by big $0.3bn outflows from China)…$6.5bn outflows from US equities (mostly via SPY and DJIA ETF), Chunky outflows from Europe ($1.2bn) for third straight week.
But, in case you wondered, these “Redemptions not large enough or sustained enough to provoke buy-signals from our [Hartnett’s] flow trading rule“.
- Gary Shilling on BTV Street Smart on Wednesday, April 11
- Mark Mobius on CNBC Squawk Box on Wednesday, April 11
- Donald Straszheim on CNBC Street Signs on Friday, April 13
- Jim Chanos on CNBC Squawk Box on Thursday, April 12
- Robert Prechter with FBN’s Neil Cavuto on Monday, April 10
1. S&P 500 Will Drop 43% this year – Gary Shilling on BTV Street Smart (04:03 minute clip) – Wednesday, April 11
A. Gary Shilling has been one of the best forecasters for the past few years. Just search for Gary Shilling in the Title & Comments section in this Blog’s advanced Search function and read his previous forecasts.
Dr. Shilling is bullish on 30-Year Treasuries and on the U.S. Dollar while he is short stocks and commodities. This fits with his call for deleveraging for the next few years. We thank Bloomberg TV PR for the excellent summary below.
Shilling on his report that the S&P will drop 43% from its recent level:
“The analysts have been cranking their numbers down. They started off north of 110 then 105. They are now 102. They are moving in my direction. I think that is true because you have foreign earnings that don’t look good because of recession unfolding in Europe, stronger dollar, so they are translation losses. A hard landing in China. In the U.S., we could see a moderate recession led by consumer retrenchment. I think that that kind of earnings estimate is not unreasonable…it’s a quartet, [I am] long treasuries, short stocks, short commodities and long the dollar.”
Shilling on the U.S. economy:
“The story is that there is nothing else except consumers that can really hype the U.S. economy. Consumers have been on a mini spending spree in terms of not keeping up. Incomes have simply not kept up. Of course, the real key behind that is employment. It looked earlier like jobs were picking up and that was going to provide the income and people would spend it, so on, so forth. But the employment report that we got last week throws cold water on that. Consumers have a lot of reasons to save as opposed to spend. They need to rebuild their assets, save for retirement. A lot of reasons suggest that they should be saving to work down debt as opposed to going the other way, which they have done in recent months. So if consumers retrench, there is not really anything else in the U.S. economy that can hold things up.”
On whether investors will come back to the U.S. market if the situation in Europe gets worse:
“Sure, we are the best of the bad lot. We’re the best horse in the glue factory. The U.S., it certainly looks better than China or Europe or certainly Japan. But, I’m not sure that that means that people go into stocks. Cash, although it does not pay anything, is an alternative. My 30-year favorite long Treasury bonds, I we’re headed for 2.5% there. They have come down from 3.2 to 3.0 recently. Of course the 10-year now has broke 2% again. I think there is still life there in terms of appreciation…I think that one and a half is possible on the 10-year.”
- “I think 1.5 is possible on the 10-year. I have to tell you, all the way down, when I got interested in 30-year bonds it was in 1981, the yield was 15.21. All the way down in yields, all the way up in price, everyone has said, rates cannot go lower, they will go up, they will go up. They have been saying that for 30 years.”
How does Dr. Shilling get to a 43% drop in the S&P? He explains in his Bloomberg Views column:
- In conjunction with a major recession in Europe, a hard
landing in China and foreign-earnings translation losses caused
by a rising dollar, the operating earnings of S&P 500 companies
could drop to $80 per share this year, compared with Wall Street
analysts’ expectations of $104. That would almost guarantee a
major bear market with a likely price-earnings ratio low of
about 10. This implies that the S&P 500 index (SPX) would be around
800, a 43 percent drop from its recent level.
2. Best Opportunity – Russia and then China – Mark Mobius on CNBC Squawk Box (05:18 minute clip) – Wednesday, April 11
Mark Mobius of Templeton Emerging Markets Group is probably the most well known EM investor. Here he speaks with CNBC’s Becky Quick. As you see, Mr. Mobius makes the perma-bulls on the U.S. stock market seem like worry warts.
- Quick – there have been all kinds of questions as to whether this spring will follow last spring’s pattern, whether this is a tipping point.
- Mobius – I think we’re in good shape. Emerging markets have outperformed other markets since the beginning of this year, so I think we’re in pretty good shape. China is looking at 7.5%. That’s their target. They may not reach that target. It may be more than that. They are having difficulty slowing down the economy. Emerging markets are generally growing to go on the average of 5%. We are getting pretty fast growth and the earnings being of course, are going to come through as result of that.
- Quick – do you think the emerging markets are going to perform well despite what happens in the developing (?) markets or will they get a boost from what happens there as well?
- Mobius – I think they are going to perform well in spite of, mainly because of the key factors. one, of course, is growth, secondly is foreign reserves, much greater than developed countries and, third, debt to gdp levels, much lower. So all of these factors add up to a very positive picture generally.
- Quick – … the central banks that we’ve watched around the globe, they have obviously changed the scenario for the last four years. At this point we’re starting to see that it’s the end of quantitative easing. If that’s the case, what’s the impact on the emerging markets?
- Mobius – well, the end of quantitative easing would not be a problem. It’s if they decide to contract. in other words, decide to take money off the table, in other words, reduce the amount of money in circulation. then that would be a problem for everybody because, of course, there won’t be enough money to move into the equities and bonds and other investments around the world. I doubt if that will happen, though.
- Quick – you don’t think that will happen? you think this will be a wait and see year?
- Mobius – I think more than that. I think Bernanke …still has got his foot on the pedal and wants to make sure that the unemployment comes down and that’s true of other countries around the world. The Europeans, Japanese, Chinese, they still want to see good growth although they are cautious about inflation.
- Quick – if you had to pick one market of the emerging markets, where do you think the best performer is going to be?
- Mobius – probably in Russia, because Russia has been beaten down, has not really performed that well. The valuations are very good. The political picture is getting better. So I might pick Russia and then China after that. Because the Chinese are now talking about boosting the A-share market to get money into the hands of the small investors in China. That will feed back into the Hong Kong H-share and the Red Chips.
- Quick – What about South East Asia? I thought you were looking at those markets as potentially strong ones. Is it hard to argue about some of the growth there?
- Mobius – I just came back from Indonesia and Thailand. They are both doing very very well. Thailand of course has outperformed already and so I can’t expect a lot more. But still they are going to do very well. Indonesia has also done very very well. You can expect more but not the kind of spectacular growth you can expect in countries where the market has been beaten down.
- Quick – You are concerned may be potentially going to happen in Singapore. May be they are tied a little more to Europe?
- Mobius – The interesting thing about Singapore is that they are getting a big flow of money coming in. Because a lot of wealthy people in the world don’t want to put their money in Switzerland because of US tax problems, and they are moving to Singapore. So they are getting the benefit of these problems in Europe and elsewhere. Also don’t forget now that Singapore has got those two huge casinos and they have been attracting a lot of tourism. So things are really humming in Singapore.
For the past couple of years, there has been an exodus of sorts going on from Switzerland to Singapore. Investors who worry about holding their physical gold in Swiss Banks are moving it
to new facilities established in Singapore. Actually, not IN Singapore. These vaults are in a special zone and you can be taken fast from the airport transit lounge directly to the vaults WITHOUT entering Singapore. So no immigration records, no passport stamps for investors. Just complete and total discretion. Smart, very smart.
Also the Swiss Private Banks are opening up offices in Singapore to serve their clients as their assets migrate there. We keep hearing of graduates from US Schools finding jobs at these Swiss Banks in Singapore, especially students of Asian origin.
3. Secular drop from 10% growth to 7% growth – Donald Straszheim on CNBC Street Signs – Friday, April 13
Donald Straszheim is the senior managing director of China research at the ISI group. Mr. Straszheim is respected as an “old China-hand”, old signifying the Asian sense of deep experience. His is a sane voice and we always listen when he speaks. Here he speaks with Brian Sullivan (@Sully) and Kelly Evans of CNBC.
- Sully – Should we be spooked Don with an 8% GDP number for China?
- Straszheim – Brian, I don’t think so. 8% is a sustainable number. People just need to understand that the 10% that China has recorded in real GDP for the last 20 years is history. We’re not going back to 10%. but 7% or 8% is still strong. It will continue to give very nice real per capita income gains to all the Chinese workers and people ought to relax.
- Evans – Don, do you think china’s bottoming in the first quarter with regards to its growth rate? I think you guys still you have a below census outlook for the rest of the year.
- Straszheim – right. we’ve had that below census outlook for the last six months or so and we still do. The difference between our forecast & the consensus is – the consensus thinks it’s first quarter down and second, third, fourth quarter up. I think it’s going to be more flat. in fact, lower second quarter than first quarter. And the reason is that China’s problems are not primarily cyclical, they are much more secular, structural and you don’t fix those problems in a month or a week or a quarter. They take years instead.
- Evans – That doesn’t sound so reassuring.
- Straszheim – Well, I think we’ll continue to have growth something like the 7% range for the next five years. I‘ll tell you that there’s 500 million people in China who have made 8% a year per capita real income gains for 25 years in a row – 1.08 to the 25th power is a pretty good career for 25 years. And 1.08 plus another 1.07 is a good 26-year career.
- Straszheim – the biggest problem in China is the basic structural imbalance, the overhang of houses for the upper half of the income distribution. that so-called commodity housing. that’s going to be very weak. those starts will go from 15 million in 2011 to about 5 million, count them, 5 million, down 67% in 2012.
- Evans – wow. that’s a big decline. it is. and it explains why you’re cautious about exports and that being a problem with a lot happening in the Eurozone.
- Straszheim – I think the export problem is a bigger problem for china than is the housing. it’s going to get fixed. but china is not as competitive as it used to be in terms of exports. Japan, America, Europe, three big developed markets for China’s exports — they’re not terrible, but they’re not great. and China’s trade surplus is already coming down and it’s going to go down more.
- Sully – bottom line, very quickly for us, Don, are either the A- shares in shanghai or H-shares in Hong Kong undervalued or overvalued?
- Straszheim – I think they are undervalued. You’ve got decent growth, no hard landing. inflation down, more to come. interest rate cuts, reserve ratio cuts. monetary policy easing. some fiscal stimulus coming. PEs that are maybe at 12 versus an average of 27. that says by and large more positives than negatives for China equities.
Now we go from the above it’s not that bad outlook to a really bearish it’s slowing faster outlook.
4. China – It’s Slowing Faster – Jim Chanos on CNBC Squawk Box – Thursday, April 12
Jim Chanos, founder of Kynikos Associates, has been the leading skeptic on China, at least in America. This week he was received warmly by CNBC’s Joe Kernen because Chanos is now recognized for being early and probably right on China. Unlike many others, Mr. Chanos gets to his opinions from the micro rather than from top-down macro. The most important point he makes is that it’s slowing faster.
- Chanos – They sent a young trader to death the other day for misappropriating money saying she was going to buy property and she traded Gold with it and they sentenced her to death….and they are looking for her husband. She has to serve 2 years in prison before they shoot her.
- Kernen – it’s going to be the slowest growth in a while but they wanted it to slow down… but what’s it mean? are they orchestrating a soft landing?
- Chanos – they are trying desperately to still cool the property sector. But that has its own problems as we know. If they say growth is going to be 8%, I can assure you it’s going to be 8% or 8.1 or 8.2…But the reality is in all things we are looking at, the property sales, cement prices, steel crisis, power consumption – it appears it’s slowing faster.
- Chanos – In China, the banks are arms of state policy...they loan because the regional party official tells them we need a new stadium, we have an empty stadium over here, it doesn’t matter. you make the loan. they’re instruments of state policy. I really doubt that the party is going to give up a lever power by breaking up the banks.…
- Sorkin – ..they’re ultimately going to be protected by the government.
- Chanos – that doesn’t mean the western shareholders are going to do well. in fact, you are the actual arm with which they’re raising capital to recapitalize. See Petrobras, see Pemex. we are going to welcome in outside minority investors and by the way, we’re going to keep tapping you over and over and over again.
- Chanos – they are really on a knife’s edge because…they can’t quite keep the technology genie in the bottle…the great firewall is increasingly porous. we saw that last year with some of the regional disturbances, people were reporting real time on the ground before they could shut them down. This is new for China. So they don’t have complete control over the media as they used to. In this day and age tipping points can be reached very quickly in society in the wrong set of circumstances.
- Chanos – no. I would be long the Chinese communist party. no, this is all financial and economic, not political.….they welcome open criticism on financial matters, but not political.
5. Rolling Over Into Deflationary Environment – Rob Prechter with FBN’s Neil Cavuto (03:16 minute clip) – Tuesday, April 10
Robert Prechter, the guru of Elliot Wave, appeared with Neil Cavuto of Fox Business this week. He repeated what he has been saying for awhile.
- Prechter – You have the sentiment, momentum measures, the Elliot Wave structure all in gear and I don’t like to bet against it…One thing people tend to forget, the market has only been down 5 trading days but the Dow wiped out 2&1/2 months of gains. It goes down faster than it goes up.
- Cavuto – There was a weird spot of a bright spot in all of this, depending on your point of view…the 10-year note went under 2%, that could be a reflection of the environment here where things look like they are slowing down..what do you make of that and what does it portend when interest rates slide, the stocks slide, what does that usually bring?
- Prechter – well, I have been saying for quite awhile that we are rolling over into a deflationary environment and the two big areas that are reflecting that are real-estate, still down 45%, and interest rates on pristine debt are very very low as you just pointed out…..we had a big rally in commodities which topped last year, they are down almost 19% from there..we have markets in gear for that trend…
- Cavuto – when you have a deflationary environment, what is a good investment in that environment? You just have cash under your mattress, what?
- Prechter – that’s the word, Cash.
- Cavuto – How long do you play that cash game?
- Prechter – well, as long as all the indicators switch to the other side…we are looking for a major low a couple of years out, and in the meantime, you just have to keep your powder dry…
We don’t understand the Cash argument. History shows that in a deflationary environment, the best asset is long duration pristine sovereign debt – in America’s case the 30-Year Treasury Bond or the 30-Year Zero Coupon Treasury Strip. Look at what has worked best in the deflationary environment in Japan that has lasted more than 20 years – long duration JGBs. So we don’t get the cash argument made by Mr. Prechter.
Send your feedback to [email protected] OR @MacroViewpoints on Twitter