My former employer, The Economist, once the ever tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its ?Big Mac? index of international currency valuations.
Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success. The index counts the cost of McDonald?s (MCD) premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.
What are its conclusions today? The Swiss franc (FXF), the Brazilian real, and the Euro (FXE) are overvalued, while the Hong Kong dollar, the Chinese Yuan (CYB), and the Thai Baht are cheap. I couldn?t agree more with many of these conclusions. It?s as if the august weekly publication was tapping The Diary of the Mad Hedge Fund Trader for ideas. I am no longer the frequent consumer of Big Macs that I once was, as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool, than a speedy lunch.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/06/McDonalds-China-e1470951249636.jpg300400Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2014-06-25 01:05:032014-06-25 01:05:03Where The Economist ?Big Mac? Index Finds Currency Value
Hedge fund titan, Jim Chanos, is well known for his extremely bearish views on China. He says that the cracks are spreading on the fa?ade, real estate sales are falling, and that the economic engine is starting to sputter.
This will be bad news for the rest of us, as China imports 50%-80% of the world?s commodities. Commodity exporting countries will be especially hard hit, like Canada, Australia, and parts of the US. Modern China has only seen a bull market, and he doubts their ability to manage a true crisis.
There is a widespread misperception that the government will step in and provide any bailouts that will be needed. The domestic Chinese banking system has in fact already been bailed out two times. The harsh reality is that while Chinese companies are selling billions of dollars? worth of new stock issues in the US through IPO?s, a privileged elite is getting their money out of the country as rapidly as they can.
Jim says that he already has short positions in the Middle Kingdom that are profitable. There is no way that even a wrinkle in a market of this size is without global implications, and on that point Jim is right.
However, I think that Jim, who confesses to having never visited China, is missing the broader long-term picture here. China has literally been building a Rome a day, the ancient kind, and the modern size every two weeks. In a year, it builds the equivalent of the entire housing stock of Spain, and in 15 years the equivalent for all of Europe.
While a lot of apartment buildings have been constructed, the country is rapidly creating the middle class to fill them. Even allowing for a pull back from its past blistering 11% per annum GDP growth rate to only 7.7%, urban disposable income per person is expected to grow by 2.5 times to $7,500 by 2020.
Over the same time frame, some 160 million are expected to move from the hinterlands to urban areas. Rising standard of livings mean that residential floor space per person will jump from 270 square feet to 369 square feet, still tiny by Western standards. That is a lot of housing demand.
China has already taken steps to head off a housing crisis, unlike the US. Many banks are now demanding cash deposits of 40%, well over the official requirement of 30%. The government is in effect forcing the banks to deleverage before hard times hit. Too bad they didn?t think of that here.
I think China still has several good years ahead of it, and I am going to pile into the stock ETF (FXI) and the Yuan ETF (CYB) as soon as the current bout of malaise selling exhausts itself. The Country?s real challenge arises when its demographic pyramid starts to invert in about five years, the result of a then 35 year old ?one child? policy, when too many single children have to start supporting two retiring parents.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/05/China.jpg316474Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2014-04-04 01:04:232014-04-04 01:04:23Why Jim Chanos is Wrong on China
Bad China data?.Russia threatens the Ukraine?.more bad China data?.maneuvers at the Russia-Crimea border. The bull has been punched out with a market that was down every day last week, China and Russia both taking turns thrashing investors, like tag team wrestlers. When will it end?
The canaries in the coal mine will be found in the charts below. This is where you will first hear the all-clear signal, when it is safe to return with an aggressive ?RISK ON? posture.
As always, watch the bond market. If the current rally in the (TLT) fails anywhere short of $110, it?s a sign that traders are fleeing the safety of the Treasury bond market and are happy to return to riskier assets, like equities. That equates to a ten year Treasury bond yield of just over 2.50%. A breakout of prices above this, and yields below suggest that more trouble is coming.
Keep close tabs on the Chinese Yuan (CYB). After an unrelenting five-year appreciation, it started a swan dive two weeks ago. That is when a banking crises in the Middle Kingdom started picking up steam. This prompted currency traders to unload Chinese renminbi for more stable dollars. The collapse of copper mirrors this. New signs of life in the Yuan and copper will hint that trouble there is over for now.
The Japanese yen is another big one to monitor. Most hedge funds borrow yen and sell them to finance long positions around the world. This is why the yen has been perennially week for the past two years. But when they dump these positions and hide under their beds, the reverse happens.
They buy back their yen shorts, pushing it up. That?s why the latest round of jitters has the Japanese currency probing four-month highs. If the yen fails here, it?s because investors are going back into the market for other assets.
Of course, the Russian stock market (RSX) is a no brainer to watch. Thanks to the antics of Vladimir Putin, it is down 28% so far in 2014, making it the world?s worst performing market this year. Invading your neighbors and threatening to incite WWIII is not good for your equities. I doubt he cares, but emerging market investors do.
Gold (GLD) is certainly earning its pay as a flight to safety instrument. It has been flying like a bat out of hell all year and is now testing major resistance. If the barbarous relic suddenly loses its luster, the memo will go out to buy paper assets once more.
Finally, keep the chart for the Volatility Index (VIX) planted on the top of your screen. Recent tops have been around the $21 level, only $3 higher than the current level. When cooler heads prevail, the (VIX) will collapse once again. Puts on the (VXX) are the way to play this move.
The interesting thing about these charts is that they are all moving to the extreme edges of multi month ranges. So we could be one more flush away from the end of this move.
That?s unless Russia really does invade Crimea in force. Then all bets are off.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/03/Atomic-Bomb.jpg334447Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2014-03-17 01:04:512014-03-17 01:04:51Charts to Watch For an End to the Crisis
The Chinese government has announced the most revolutionary changes to its economy in nearly four decades. The implications for global stock markets are hugely positive, and until now, under appreciated. The Middle Kingdom?s state controlled media, never prone to hyperbole, are calling it ?a new historical starting point.?
Chinese stocks have rocketed since word of the broad ranging reforms leaked out last week, and appear to have much more to go. This brings to an end the 3 ? year Chinese growth recession, which saw GDP growth rates shrink from a white hot 13% annual rate, down to a more modest 7%. Until last week, Chinese capital markets were neglected, ignored, and left stranded on a back burner.
This is great news for all of us.
The sea of change promised by the events in the Middle Kingdom barely caught notice in the West, where investors were transfixed by the never ending rise of US equities and other risk assets. But my friends at the senior levels of the Chinese government have been gushing about the great things to come. They compare it to the 1978 revolution, when the ?Gang of Four? was thrown out, and Deng Xiaoping was named premier.
Some 35 years of wildly successful modernization, westernization, and capitalization followed. Chinese per capita incomes skyrocketed, from $100 to $6,000 today. The current round of liberalizations could eventually bring Chinese standards of living to American levels. Give it another 35 years.
Of course, reading the statement issued by the 370 senior party members of the third plenum of the 18th Central Committee, you get no clue of the brave new world they promise. These are always written in obscure code words whose meaning can only be deciphered by tracking nuances, changes, and references over decades. I have been doing this since the early seventies, when Mao Zedong was calling the shots, longer than most Chinese. It was a lot harder then, or am I simply getting wiser in my old age?
The goal of the reforms is to move China from its current emerging status towards middle class. The one child policy was abandoned, which has cut the country?s population growth by 400 million over the last 30 years. This should add back in 400 million in population growth over the next 35 years. Not to do so would risk labor shortages looming in the 2020?s, and the runaway wage inflation that invariably follows.
Internal passports that restricted population movements were abolished. Private property rights are receiving a boost. The economy will become more market oriented. The Chinese gulag that imprisoned tens of thousands was sent to the dustbin of history. The strengthening of the country?s social safety net will free up domestic Chinese savings, which now at 30%, are among the highest in the world. This will bring a surge in consumer spending.
Financial reforms are expected to follow soon. These include a more aggressive path towards a free float of the Chinese Yuan, known locally as the ?renminbi,? or ?people?s currency.? The breadth and depth of domestically traded debt instruments will be greatly expanded. You can expect far more active investment of the country?s nearly $4 trillion foreign exchange hoard abroad, especially in trophy assets in safe havens like the US and the UK. They are already soaking up commercial property loans by the billions here in the San Francisco Bay area.
This will accelerate the evolution of the Chinese economy from an export oriented consuming one to one that is more oriented towards domestic consumption. This is big.
The net net of all this will be to enhance the productivity and profitability of Chinese companies. That is what the Chinese stock markets have been screaming at us since last week.
The prospects for the world economy have been much improved by this second Chinese modernization. Rising Chinese standards of living will produce hundreds of millions of new consumers of American and European goods. Emerging markets (EEM), many of which are indirect China plays, do pretty well in the new paradigm as well. All in all, this should add many percentage points of growth to the world economy in coming decades.
It certainly makes my own forecast of a global synchronized recovery 2014 look good as well. As for stock markets everywhere, think higher, and for longer. ?RISK ON? is ?ON.?
The no brainer here is to buy the iShares FTSE China 25 Index Fund ETF (FXI), which has to rise by 63% just to match its 2007 high. The Chinese economy has more than doubled in size since then, making today?s (FXI) level relatively much cheaper. During this time, Chinese earnings multiples have gone from a huge premium to US ones to a large discount, making them a great rotation play.
If you want to sleep at night, buy the Hong Kong ETF (EWH), where accounting and disclosure standards are on par with those of England, a legacy from its colonial days. You can expect to Chinese Yuan ETF (CYB) to continue its northward market, as I have been predicting for the past four years.
You can also go into single stock plays, like China Mobile (CHL), the world?s largest phone company. Something tells me there are a lot of new customers and upgrades in its future.
Looks like there is going to be a lot more dim sum in my future.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/11/Deng-Xiaoping.jpg372369Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-11-19 13:00:022013-11-19 13:00:02CHINESE REFORMS WILL SEND US STOCKS SKYWARD - Update
Any trader will tell you the trend is your friend, and the overwhelming direction for the US dollar for the last 220 years has been down.
Our first Treasury Secretary, Alexander Hamilton, found himself constantly embroiled in sex scandals. Take a ten-dollar bill out of your wallet and you?re looking at a picture of a world class horndog, a swordsman of the first order. When he wasn?t fighting libelous accusations in the press and the courts, he spent much of his six years in office orchestrating a rescue of our new currency, the US dollar.
Winning the Revolutionary War bankrupted the young United States, draining it of resources and leaving it with huge debts. Hamilton settled many of these by giving creditors notes exchangeable for then worthless Indian land west of the Appalachians.
As soon as the ink was dry on these promissory notes, they traded in the secondary market for as low as 25% of face value, beginning a century?s long government tradition of stiffing its lenders, a practice that continues to this day. ?My unfortunate ancestors took him up on his offer, the end result being that I am now writing this letter to you from California?and am part Indian.
It all ended in tears for Hamilton, who, misjudging former Vice President Aaron Burr?s intentions in a New Jersey duel, ended up with a bullet in his back that severed his spinal cord.
Since Bloomberg machines weren?t around in 1790, we have to rely on alternative valuation measures for the dollar then, like purchasing power parity, and the value of goods priced in gold. A chart of this data shows an undeniable permanent downtrend, which greatly accelerates after 1933 when Franklin Delano Roosevelt took the US off the gold standard, banned private ownership of the barbarous relic, and devalued the dollar. Gold bugs have despised him ever since.
Today, going short the currency of the world?s largest borrower, running the greatest trade and current account deficits in history, with a diminishing long term growth rate is a no brainer. But once it became every hedge fund trader?s free lunch, and positions became so lopsided against the buck, a reversal was inevitable. We seem to be solidly in one of those periodic corrections, which began two weeks ago month ago, and could continue for months, or even years.
The euro has its own particular problems, with the cost of a generous social safety net sending EC budget deficits careening. Use this strength in the greenback to scale into core long positions in the currencies of countries that are major commodity exporters, boast rising trade and current account surpluses, and possess small consuming populations.
I?m talking about the Canadian dollar (FXC), the Australian dollar (FXA), and the New Zealand dollar (BNZ), all of which will eventually hit parity with the greenback. Think of these as emerging markets where they speak English, best played through the local currencies.
For a sleeper, buy the Chinese Yuan ETF (CYB) for your bank book. A major revaluation by the Middle Kingdom is just a matter of time.
I?m sure that if Alexander Hamilton were alive today, he would counsel our modern Treasury Secretary, Jack Lew, to talk the dollar up, but to do everything he could to undermine the buck behind the scenes, thus over time depreciating our national debt down to nothing through a stealth devaluation. (Click here for my interview with him, ?Riding with Treasury Secretary Jack Lew.)
Given Lew?s performance so far, I?d say he studied his history well.
https://www.madhedgefundtrader.com/wp-content/uploads/2011/12/TenDollarBill.jpg135320Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-11-07 01:03:182013-11-07 01:03:18Enjoy the Dollar Rally While it Lasts
One of the oldest games in the foreign exchange market is to always buy the currencies of strong countries that are growing, and to sell short the currencies of the weak countries that are shrinking.
Any doubts that China?s Yuan is a huge screaming buy should have been dispelled when news came out that it had displaced Germany as the world?s largest exporter.
The Middle Kingdom shipped $1.2 trillion in goods in 2009, compared to only $1.1 trillion for The Fatherland. The US has not held the top spot since 2003. China?s surging exports of electrical machinery, power generation equipment, clothes, and steel were a major contributor. German exports were mired down by lackluster economic recovery in the EC, which has also been a major factor behind the weak euro. Sales of luxury Mercedes and BMW cars, machinery, and chemicals have plummeted.
Interest rate rises for the Yuan and a constant snugging of bank reserve requirements by the People?s Bank of China, have stiffened the backbone of the Middle Kingdom?s currency even further. That is the price of allowing the Federal Reserve to set China?s monetary policy via a semi fixed Yuan exchange rate. It is certain that Obama?s stimulus programs are reviving China?s economy more than our own.
The last really big currency realignment was a series of devaluations that took the Yuan down from a high of 1.50 to the dollar in 1980. By the mid-nineties, it had depreciated by 84%. The goal was to make exports more competitive. The Chinese succeeded beyond their wildest dreams.
There is absolutely no way that the fixed rate regime can continue, and there are only two possible outcomes. An artificially low Yuan has to eventually cause the country?s inflation rate to explode. Or a future global economic recovery causes Chinese exports to balloon to politically intolerable levels. Either case forces a revaluation.
Of course timing is everything. It?s tough to know how many sticks it takes to break a camel?s back. Talk to senior officials at the People?s Bank of China, and they?ll tell you they still need a weak currency to develop their impoverished economy. Per capita income is still at only $6,000, less than a tenth of that of the US. But that is up a lot from a mere $100 in 1978.
Talk to senior US Treasury officials, and they?ll tell you they are amazed that the Chinese peg has lasted this long. How many exports will it take to break it? $1.5 trillion, $2 trillion, $2.5 trillion? It?s anyone?s guess.
The truly amazing thing is that the Yuan has maintained its strength in the face of a widespread collapse of currencies across the rest of the emerging market (EEM) space. Could this be your big ?BUY? signal?
One thing is certain. A free floating Yuan would be at least 50% higher than it is today, and possibly 100%. In fact, the desire to prevent foreign hedge funds from making a killing in the market is a not a small element in Beijing?s thinking.
The Chinese Central bank governor, Zhou Xiaochuan, says he won?t entertain a revaluation for the foreseeable future. The Americans say they need it tomorrow. To me that means about six months. Buy the Yuan ETF, the (CYB). Just think of it as an ETF with an attached lottery ticket. If the Chinese continue to stonewall, you will get the token 3%-4% annual revaluation they are thought to tolerate. Double that with margin, and your yield rises to 6%-10%, not bad in this low yielding world. Since the chance of the Chinese devaluing is nil, that beats the hell out of the zero interest rates you now get with T-bills.
If they cave, then you could be in for a home run.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/09/Girl-Chinese.jpg376284Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-09-19 01:04:582013-09-19 01:04:58Play China?s Yuan From the Long Side
My former employer, The Economist, once the ever tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its ?Big Mac? index of international currency valuations.
Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success. The index counts the cost of McDonald?s (MCD) premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.
What are its conclusions today? The Swiss franc (FXF), the Brazilian real, and the Euro (FXE) are overvalued, while the Hong Kong dollar, the Chinese Yuan (CYB), and the Thai Baht are cheap. I couldn?t agree more with many of these conclusions. It?s as if the august weekly publication was tapping The Diary of the Mad Hedge Fund Trader for ideas. I am no longer the frequent consumer of Big Macs that I once was, as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool, than a speedy lunch.
https://www.madhedgefundtrader.com/wp-content/uploads/2011/12/mcdonaldsJapan.jpg240320Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-06-26 01:04:532013-06-26 01:04:53Where the Economist ?Big Mac? Index Finds Currency Value.
Hedge fund titan, Jim Chanos, is well known for his extremely bearish views on China. He says that the cracks are spreading on the fa?ade, real estate sales are falling, and that the economic engine is starting to sputter.
This will be bad news for the rest of us, as China imports 50%-80% of the world?s commodities. Commodity exporting countries will be especially hard hit, like Canada, Australia, and parts of the US. Modern China has only seen a bull market, and he doubts their ability to manage a true crisis.
There is a widespread misperception that the government will step in and provide any bailouts that will be needed. The domestic Chinese banking system has in fact already been bailed out two times. The harsh reality is that while Chinese companies are selling billions of dollars? worth of new stock issues in the US through IPO?s, a privileged elite is getting their money out of the country as rapidly as they can. Jim says that he already has short positions in the Middle Kingdom that are profitable. There is no way that even a wrinkle in a market of this size is without global implications, and on that point Jim is right.
However, I think that Jim, who confesses to having never visited China, is missing the broader long-term picture here. China has literally been building a Rome a day, the ancient kind, and the modern size every two weeks. In a year, it builds the equivalent of the entire housing stock of Spain, and in 15 years the equivalent for all of Europe.
While a lot of apartment buildings have been constructed, the country is rapidly creating the middle class to fill them. Even allowing for a pull back from its past blistering 11% per annum GDP growth rate to only 7.7%, urban disposable income per person is expected to grow by 2.5 times to $7,500 by 2020.
Over the same time frame, some 160 million are expected to move from the hinterlands to urban areas. Rising standard of livings mean that residential floor space per person will jump from 270 square feet to 369 square feet, still tiny by Western standards. That is a lot of housing demand.
China has already taken steps to head off a housing crisis, unlike the US. The People?s Bank of China has raised bank reserve requirements five times, taking them to among the most stringent levels in the world. That is almost Canadian in its conservatism. Many banks are now demanding cash deposits of 40%, well over the official requirement of 30%. The government is in effect forcing the banks to deleverage before hard times hit. Too bad they didn?t think of that here.
I think China still has several good years ahead of it, and I am going to pile into the stock ETF (FXI) and the Yuan ETF (CYB) as soon as the current bout of malaise selling exhausts itself. The Country?s real challenge arises when its demographic pyramid starts to invert in about five years, the result of a then 35 year old ?one child? policy, when too many single children have to start supporting two retiring parents.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/05/China.jpg316474Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-05-31 08:23:202013-05-31 08:23:20Why Jim Chanos is Wrong on China
Any doubts that the Chinese Yuan is a huge screaming buy should have been dispelled when news came out that China had displaced Germany as the world?s largest exporter. The Middle Kingdom shipped $1.9 trillion in goods in 2012, compared to only $1.4 trillion for Deutschland. The US has not held the top spot since 2003.
China?s surging exports of electrical machinery, power generation equipment, clothes, and steel were a major contributor. German exports were mired down by lackluster economic recovery in the EC, which has also been a major factor behind the weak euro. Sales of luxury Mercedes and BMW cars, machinery, and chemicals have cratered.
Back-to-back interest rate rises for the Yuan, and a snugging of bank reserve requirements by the People?s Bank of China, have stiffened the backbone of the Yuan even further. That is the price of allowing the Federal Reserve to set China?s monetary policy via a fixed Yuan exchange rate. Is it possible that Obama?s stimulus program is reviving China?s economy more than our own? That?s what highly divergent economic growth rates suggest, with China taking on 8% a year, versus only 2% for the US.
The last really big currency realignment was a series of devaluations that took the Yuan down from a high of 1.50 to the dollar in 1980. By the mid nineties it had depreciated by 84%. The goal was to make exports more competitive. The Chinese succeeded beyond their wildest dreams. This is why today?s Chinese complaints that Japan is using their country as a ?garbage dump? for the yen is falling on deaf ears in Tokyo.
There is absolutely no way that the fixed Yuan rate regime can continue. There are only two possible outcomes. An artificially low Yuan has to eventually cause the country?s inflation rate to explode. Or a global economic recovery causes Chinese exports to balloon to politically intolerable levels. Either case forces a major Yuan revaluation.
Of course, timing is everything. It?s tough to know how many sticks it takes to break a camel?s back. Talk to senior officials at the People?s Bank of China, and they?ll tell you they still need a weak currency to develop their impoverished economy. Per capita income is still at only $5,000, a tenth of that of the US. But that is up a lot from $100 in 1978. I remember the grinding poverty of the ?old? China all too well.
Talk to senior US Treasury officials, and they?ll tell you they are amazed that the Chinese peg has lasted this long. How many exports will it take to break it? $2 trillion, $3 trillion, or $24 trillion? It?s anyone?s guess.
One thing is certain. A free-floating Yuan would be at least 50% higher than it is today, and possibly 100%. In fact, the desire to prevent foreign hedge funds from making a killing in the market is not a small element in Beijing?s thinking. The Chinese Central bank governor says he won?t entertain a revaluation for the foreseeable future. The Americans say they need it tomorrow.
To me, that means about six months. Buy the Yuan ETF, the (CYB). Just think of it as an ETF with an attached lottery ticket. If the Chinese continue to stonewall, you will get the token 3% annual revaluation the swaps have been discounting. Since the chance of the Chinese devaluing is nil, that beats the hell out of the zero interest rates you now get with T-bills. If they cave, then you could be in for a home run.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/03/Yuan.jpg292418Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-03-12 09:26:212013-03-12 09:26:21Load the Boat With the Chinese Yuan
I am writing this report from a first class cabin on Amtrak?s California Zephyr en route from Chicago to San Francisco. The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sage brush and salt flats of Northern Nevada outside my window, so there is nothing else to do but to write. My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca. It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.
After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2011 was the most hellacious in careers lasting 30, 40, or 50 years. With the S&P 500 up 0.4% 2011, following a roaring 0.04% decline in 2010, the average hedge fund was up a pitiful 1%, and thousands lost money.
It is said that those who ignore history are doomed to repeat it. I am sorry to tell you that we are about to endure 2011 all over again. You can count on another 12 months of high volatility, gap moves at the opening, tape bombs, a lot of buying of rumors and selling of news, promises and disappointments from governments, and American markets being held hostage to developments overseas.
If you lost money in 2011, you will probably do so again in 2012, and should consider changing your line of work. It takes a special kind of person to make money in markets like these; someone who thrives on raw data and ignores the hype and the spin, who invests based on facts and not beliefs, and who thinks all things can happen at all times.? In other words, you need somebody like me, as my 40% return last year will attest. Those who don?t think they are up to it might consider pursuing that long delayed ambition to open a trendy restaurant, the thoughtful antique store, or finally get their golf score down to 80.
If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:
*Long term structural issues will overwhelm short term positives.
*Corporate profits continue to grow, but at a much slower rate, reaching diminishing returns.
*2009 stimulus spending is a distant memory, and there will be no replays.
*Bush tax cuts expire, creating a 1% drag on GDP.
*An epochal downsizing continues by state and local governments, chopping another 2-3% off of GDP.
*A recession in Europe further reduces American growth by 1%.
*Expect an actual default out of the continent in 2012, certainly from Greece, possibly also from Portugal and Ireland.
*There will be no QE3, since QE2 never filtered down to the real economy. There is little the Fed can do to help us.
*Huge demographic headwinds bring another leg down in the residential real estate market.
*The first baby boomer hit 65 last year and it is now time to pay the piper on entitlements.
*The new hot button social issue will become ?senior homelessness,? as millions retire without a cent in the bank and are unable to find jobs.
*Falling home prices bring secondary banking crisis, but this time there will be no TARP and no bail outs
*Gridlock in Washington prevents any real government solution, and there is nothing they can do anyway.
*Candidates from both parties will attempt to convince us that their opponents are crooks, thieves, idiots, or ideologues, and largely succeed. That will leave the rest of us confused and puzzled, and less likely to invest or hire.
*Unemployment remains stuck at an 8-9% level, then ratchets up to 15%. The real, U-6 rate soars to 25%.
Now let me give you a list of possible surprise positives, which may mitigate the list of negatives above.
*American multinationals continue to squeeze more blood out of a turnip and post stellar earnings increases yet again.
*China successfully slams the breaks on the real estate market without cutting the rest of the economy off at the knees and engineers a soft landing with 7%-8% GDP growth.
*Europe somehow pulls a new treaty out of its hat that addresses its structural financial and monetary shortfalls a decade ahead of schedule.
*Through some miracle, the American consumer keeps spending at the expense of a declining savings rate. There is evidence that this has been going on since October.
The Election Will Not Be Good for Risk Assets
So, let me summarize what your 2012 will look like. The ?RISK ON? trade that started on October 4 will spill into the new year, driven by value players loading up on cheap multinationals, chased by frantically short covering hedge funds, hitting a peak sometime in Q1. The S&P 500 could reach 1,350. In Q2 and Q3 traders will have to deal with flocks of black swans, giving 4-7 months of the ?RISK OFF? trade. We should rally into Q4 as markets discount the end of the election cycle. It really makes no difference who wins. The mere disappearance of electioneering will be positive for risk takers.
I Said ?Black Swans,? Not Crows!
The Thumbnail Portfolio
Equities-A ?V? shaped year, up, down, then up again Bonds-Treasuries grind towards new 60 year peaks, then an eventual collapse Currencies-dollar up and Euro and Australian, Canadian and New Zealand dollars down Commodities-Look to buy for a long term hold mid-year Precious Metals-take a longer rest, then up again Real estate-multifamily up, single family down, commercial sideways
1) The Economy-The Second Lost Decade Continues
I am sticking with a 2% growth forecast for 2012. I see the huge list of negatives above that add up to at least a 5% drag on the economy. There is only one positive that we can really count on. Corporate earnings will probably come in at $105 a share for the S&P 500 this year, a gain of 15% over the previous year, and a double off the 2008 lows. During the last three years we have seen the most dramatic increase in earnings in history, taking them to all-time highs, no matter how much management complains about over regulation.
Can the magic continue? I think not. Slowing economies in China and Europe will fail to deliver the stellar gains seen in 2011, which account for half the profits of many large multinationals.? A global economy that grew at 4.1% in 2010 and 2.5% in 2011 will probably eke out only a subdued 1.5% in 2012. A strong dollar will further eat into foreign revenues.
Cost cutting through layoffs is reaching an end as there is no one left to fire. Growing companies can?t delay new hires forever. That leaves technology as the sole remaining source of margin increases, which will continue its inexorable improvements. So corporate earnings will rise again in 2012, but possibly only by 5%-10%? to $105-$110 for the $S&P 500. Hint: technology will be the top performing sector in the market in 2012, with Apple (AAPL) taking the lead.
Deleveraging will remain a dominant factor affecting the economy for another 5-8 years. Much of the hyper growth we witnessed over the past 30 years, possibly half, was borrowed from the future through excessive credit, and it is now time to pay the piper. We are still at the beginning of a second lost decade. Don?t expect a robust GDP while governments, corporations, and individuals are sucking money out of the economy. This lines up nicely with my 2% target.
Forget about employment. The news will always be bad. I believe that the US has entered a period of long term structural unemployment similar to what Germany saw in the 1990?s. Yes, we may grind down to 8% before the election. But the next big move in this closely watched indicator is up, possible as high as 15%. Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read of the financial markets to head in a ?RISK ON? or ?RISK OFF? direction.
With a GDP growing at a feeble 2% in 2012, and corporate earnings topping out at $105-$110 a share, those with a traditional buy and old approach to the stock market will fare better taking this year off. While earnings are growing, multiples will shrink from 13 to 12, multiple? for the indexes unchanged. It is also possible that the economy will never meet the textbook definition of a recession, that of two back to back quarters of negative GDP numbers.? But the market will think the economy is going into recession and behave accordingly. ?Double dip? will get dusted off one again. Remember how ?Sell in May and Go Away? has worked so well for the past three years? This year you may want to sell in January.
I am looking for some new liquidity from value players and additional short covering to spill over into the New Year, possibly taking us up to 1,325-$1,350. If we get that high, take it as a gift, as the big hedge funds will be very happy to pile on the leveraged shorts at the top of a multiyear range.
A continuing stream of positive economic data will also help. Since we don?t have the ?oomph? offered by the tax compromise and QE2 a year ago, look for equities to peak much earlier than the April 29 apex we saw in 2011. The trigger for this deluge could be a sudden spike in jobless claims as the temporary Christmas hires are fired combined with economic data that cools coming off a hot Q4.
Let me tell you why the value players up here don?t get it. A 2% growth rate doesn?t justify the 10-22 price earnings multiple range that we have enjoyed during the last 30 years. At best it can support an 8-16 range, or maybe even the 6-15 range that prevailed when I first started on Wall Street 40 years ago. That makes the current 13 multiple look cheap according to old models, but expensive in the new paradigm.
When the guys in the white coats show up to drag away the value managers, they will be screaming that ?They were cheap,? all the way to the insane asylum. What these hapless souls didn?t grasp was that we are only four years into a secular, decade long downtrend in PE multiples, the bottom for which is anyone?s guess.
After that, the way should be clear for a 25% swoon down to 1,000, which will happen sometime in Q2 or Q3. That will be caused by a ton of new short selling triggered by the break of the 2011 low at 1,070, which then get stopped out on the upside. The heating up of trouble with Iran is another unpredictable variable, which is really just a pretext for attacking Syria, their only ally. How will the market decline in the face of growing earnings? That is exactly what markets did in 2011, once the fear trade was posted on the mast for all to see?
Crash, we won?t, and this is what my Armageddon friends don?t get. To break to new lows, you need sellers, and lots of them. Those were in abundance in 2008, when the bear market caught many completely by surprise, everyone was leveraged to the hilt, and risk controls provided all the security of wet tissue paper.
This time around it?s different. Prime brokers now require a pound of flesh as collateral, especially in the wake of the MF Global Bankruptcy, and leverage as almost an extinct species. In the meantime, individuals have been decamping from stocks en masse, with equity mutual fund sales over the past three year hitting $400 billion, compared to $800 billion in bond fund purchases. That will leave hedge funds the only players at an (SPX) of 1,000, who will be loath to run big shorts at multiyear bottoms. You can?t have a crash if there is no one left to sell.
That gives us the juice to rally into Q4, just as the presidential election is coming to an end. It really makes no difference who wins, as long as one doesn?t get control all three branches of government. My money is on Obama, who has the highest approval rate in history with unemployment at 8.6%. The mere fact that the election is over will lift a cloud of uncertainty overhanging risk assets. It will be a real stretch to hope that stock markets will close unchanged in 2012, as we did in 2011. My expectation is for a single digit loss for 2012.
This Could? be the Big Trade of 2012
Equities will be no place for old men
3) Bonds?? (TBT), (JNK), (PHB), (HYG), (PCY)
The single worst call by myself and the hedge fund industry at large this year was that massive borrowing by the Federal government would cause the Treasury bond market to collapse. Not only did it fail to do so, it blasted through to new 60 year highs, sending ten year yields to 1.80%, which adjusted for inflation is a real negative yield of -1.5% a year.
Investors today will get back 80 cents worth of purchasing power at maturity for every dollar they invest. But institutions and individuals will grudgingly lock in these appalling returns because they believe that the losses in any other asset class will be much greater.
What I underestimated was the absolute perniciousness of today?s deflation. The price for everything you want to sell is continuing a relentless fall, including your home and your labor.? The cost of the things you need to buy, like food, energy, health care, and education, is rocketing. Globalization is the fat on the fire. I call this ?The New Inflation?. This goes a long way in explaining the causes behind a 30 year decline in the middle class standard of living.
The other thing I miscalculated on was how rapid contagion fears spread from Europe. When the world gets into trouble, everyone picks up their marbles and goes home. For the financial markets, that translates into massive buying of the core ?flight to safety? assets of the US dollar and Treasury bonds.
While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite. A 1.80%, ten year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough. Given the choice between what a politician wants me to believe and the harsh judgment of the marketplace, I will take the latter every time.
So what will 2012 bring us? More of the same. For a start, we have seen a substantial ?RISK ON? rally for the past three months where equities tacked on a virile 20% gain. Bond yields have ticked up barely 30 basis points from the lows, not believing in the longevity of this rally for one nanosecond. That tells me that the next equity sell off could see Treasury yields punch through to new lows, possibly down to 1.60%. Given even a modest recession, bond yields could touch 1%.
Surveying the rocky landscape that lies ahead of me, I expect to get five months of ?RISK ON? conditions and a turbulent and volatile seven months of ?RISK OFF?. This augers very well for a continuation of the bull market in Treasuries at least until August.
This scenario does not presage a good year for the riskiest corner of the fixed income asset class - junk bonds, whose default rates are not coming in anywhere near where they were predicted just a few months ago. Don?t get enticed by the siren song of high yields by the junk ETF?s, like (JNK), (PHB), and the (HYG). There will be better buying opportunities down the road.
As for municipal bonds, we are seeing only the opening act of a decade of fiscal woes by local government. Still, there is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase muni values. The continued bull market in Treasuries will do the same.
So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way. Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits. And thank Meredith Whitney for creating the greatest buying opportunity in history for muni bonds a year ago.
Perhaps the best place to live in bond world is in emerging market debt, where you can participate via the (PCY). At least there, you have the tailwinds of strong economies, little outstanding debt, appreciating currencies, and already high interest rates. But don?t buy here. This is something you want to pick up at the nadir of a ?RISK OFF? cycle, when the dollar and Treasury markets are peaking.
(FXC)
The Fat Lady Will Have to Wait to Sing for the Treasury Market
Any trader will tell you to never bet against the trend, and the overwhelming direction for the US dollar for the last 220 years has been down. The only question is how far, how fast. Going short the currency of the world?s largest borrower, running the greatest trade and current account deficits in history, with a diminishing long term growth rate is a no brainer.
But once it became every hedge fund trader?s free lunch, and positions became so lopsided against the buck, a reversal was inevitable. We seem to be solidly in one of those periodic bear market corrections, which began in March and could continue for several more months, or even years.
The big driver of the currency markets is interest rate differentials. With US interest rates safely at zero, and the rest of the world chopping theirs as fast as they can, this will provide a very strong tailwind for the greenback for much of 2012. Use rallies to sell short the Euro (FXE), (EUO), the Canadian dollar (FXC), the high beta Australian dollar (FXA), and the lagging New Zealand dollar (BNZ). Australians could see a print of 85 cents before the bloodletting is over, and should pay for their upcoming imports and foreign vacations now, while their currency is still dear.
The Euro presents a particular quandary for foreign exchange traders, with a never ending sovereign debt crisis causing its death through a thousand cuts. Just look at Greece, with a budget deficit of 13% of GDP against the 3% it promised on admission to the once exclusive club. But this is not exactly new news, and traders have already built shorts to all-time records. Still, the next crisis in confidence could easily take the Euro to $1.25, and new momentum driven shorts could take us to the $1.17?s.
As far as the Japanese yen is concerned, I am going to stay away. How the world?s worst economy has managed to maintain the planet?s strongest currency is beyond me. The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate. But until someone provides me with a convincing explanation, or until the yen decisively reverses, I?ll pass. Let hedge fund manager, Kyle Bass, figure this one out.
For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book, but don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth to in order to keep its appreciation modest to maintain their crucial export competitiveness.
This is my favorite asset class for the next decade, as investors increasingly catch on to the secular move out of paper assets into hard ones. Don?t buy anything that can be manufactured with a printing press. Focus instead on assets that are in short supply, are enjoying an exponential growth in demand, and take five years to bring new supply online. The Malthusian argument on population growth also applies to commodities; hyperbolic demand inevitably overwhelms linear supply growth.
Of course, we?re already nine years into what is probably a 30 year secular bull market for commodities and these things are no longer as cheap as they once were. You?ll never buy copper again at 85 cents a pound, versus today?s $3.40. You are going to have to allow these things to breathe. Ultimately, this is a demographic play that cashes in on rising standards of living in the biggest and highest growth emerging markets. You can start with the traditional base commodities of copper and iron ore.
The derivative equity plays here are Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE). Add the energies of oil (DIG), coal (KOL), uranium (NLR), and the equities Transocean (RIG), Joy Global (JOY), and Cameco (CCJ).
As much as I love the long term case for hard commodities, I am not expecting any action in the immediate future. Commodities will remain a no go area until it is clear whether China?s economy will suffer a soft or a hard landing, or continues to remain airborne. Use this year?s big ?RISK OFF? trade to acquire serious positions. If markets rally into year end, you might catch a quick 50% gain in the more volatile securities.
Oil has in fact become the new global de facto currency, and probably $30 of the current $100 price reflects monetary demand, and another $30 representing a Middle Eastern risk premium. Strip out these factors, and oil should be trading at $40.? That will help it grind to $100 sometime in early 2012, and we could spike as high as $120. After that, the ?RISK OFF? trade could take it back down to the $75 we saw in September.
Skip natural gas (UNG), because the discovery of a new 100 year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time. Major reforms are required in Washington before use of this molecule goes mainstream.
The food commodities are also a great long term Malthusian play, with corn (CORN), wheat (WEAT), and soybeans (SOYB) coming off the back of great returns in 2010. These can be played through the futures or the ETF?s (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU). The grain ETF (JJG) is another handy play. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cake walk. You can participate in this most liquid of asset with the ETF?s (PHO) and (FIW).
Let?s face it, gold is not a hard asset anymore, it?s a paper one. Since hedge funds and high frequency traders moved into this space, the barbarous relic has been tracking one for one with the S&P 500 and other risk assets.
The chip shot here is $1,500 on the downside, once the remaining hedge fund redemptions and other hot money are cleared out. If we have a real recession this year, $1,050 might be doable. Remember, the speculative frenzy is as great as it was in 1979, which saw the beginning of a 75% plunge in the yellow metal.
But the long term bull case is still there. Obama has not suddenly become a paragon of fiscal restraint. Bernanke has not morphed into a tightwad. When I pull a dollar bill out of my wallet, it?s as limp as ever.
If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely overbought condition before we make substantial new highs. Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.
If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP). But you should only go into these as part of a broader ?RISK ON? move.
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal,+ silver (SLV), which I think could hit $50 once more. Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf would also be something to consider on a dip.
Here?s a Nice Busted Bubble
6) Real Estate
There is no point in spending much time on this most unloved of asset classes, so I?ll keep it brief. There are only three numbers you need to know in the housing market: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 85 million in the generation after that, the Millennials.
The boomers have been desperately trying to unload dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of them, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. If they have prospered, banks won?t lend to them.
Now consider the coming changes that will affect this market. The home mortgage deduction is unlikely to survive any attempt to balance the budget. And why should renters be subsidizing homeowners anyway? Nor is the government likely to spend billions keeping Fannie Mae and Freddie Mac alive, which now account for 95% of home mortgages.
That means the home loan market will be privatized, leading to mortgages rates 200 basis points higher than today. If this sounds extreme, look no further than the jumbo market for proof. It is already bereft of government subsidy, and loans here are now priced at premiums of this size. This also means that the fixed rate 30 year loan will disappear, as banks seek to offload duration risk to consumers. This happened long ago in the rest of the developed world.
There is a happy ending to this story. By 2025 the Millennials will start to kick in as the dominant buyers in the market. Some 85 million Millennials will be chasing the homes of only 65 Gen Xer?s, causing housing shortages and rising prices. This will happen in the context of a labor shortfall and rising standards of living. In fact, the mid 2020?s could bring a repeat of our last golden age, the 1950?s.
The best case scenario for residential real estate is that it bounces along a bottom for another decade. The worst case is that it falls another 25% from here. Only buy a home if your wife is nagging you about living in that cardboard box under the freeway overpass. But expect to put up your first born child as collateral, and bring in your entire extended family in as cosigners if you want to get a bank loan. Then pray that the price starts to go up in 15 years. Rent, don?t buy.
Rent, Don?t Buy
Well, that?s all for now. We?ve just passed the Pacific mothball fleet and we?re crossing the Benicia Bridge, where the Sacramento River pours into San Francisco Bay. The pressure drop caused by an 8,000 foot descent from Donner Pass has crushed my water bottle. The Golden Gate and the soaring spire of the Transamerica building are just around the next bend. So it is time for me to unglug my laptop and pack up.
I?ll shoot you a trade alert whenever I see a window open on any of the trades above. Good trading in 2012!
https://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.png00DougDhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngDougD2012-01-02 21:00:542012-01-02 21:00:542012 Annual Asset Class Review
Legal Disclaimer
There is a very high degree of risk involved in trading. Past results are not indicative of future returns. MadHedgeFundTrader.com and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, strategies, columns, articles and all other features are for educational purposes only and should not be construed as investment advice. Information for futures trading observations are obtained from sources believed to be reliable, but we do not warrant its completeness or accuracy, or warrant any results from the use of the information. Your use of the trading observations is entirely at your own risk and it is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with your broker and make your own independent decisions regarding any securities mentioned herein. Affiliates of MadHedgeFundTrader.com may have a position or effect transactions in the securities described herein (or options thereon) and/or otherwise employ trading strategies that may be consistent or inconsistent with the provided strategies.
We may request cookies to be set on your device. We use cookies to let us know when you visit our websites, how you interact with us, to enrich your user experience, and to customize your relationship with our website.
Click on the different category headings to find out more. You can also change some of your preferences. Note that blocking some types of cookies may impact your experience on our websites and the services we are able to offer.
Essential Website Cookies
These cookies are strictly necessary to provide you with services available through our website and to use some of its features.
Because these cookies are strictly necessary to deliver the website, refuseing them will have impact how our site functions. You always can block or delete cookies by changing your browser settings and force blocking all cookies on this website. But this will always prompt you to accept/refuse cookies when revisiting our site.
We fully respect if you want to refuse cookies but to avoid asking you again and again kindly allow us to store a cookie for that. You are free to opt out any time or opt in for other cookies to get a better experience. If you refuse cookies we will remove all set cookies in our domain.
We provide you with a list of stored cookies on your computer in our domain so you can check what we stored. Due to security reasons we are not able to show or modify cookies from other domains. You can check these in your browser security settings.
Google Analytics Cookies
These cookies collect information that is used either in aggregate form to help us understand how our website is being used or how effective our marketing campaigns are, or to help us customize our website and application for you in order to enhance your experience.
If you do not want that we track your visist to our site you can disable tracking in your browser here:
Other external services
We also use different external services like Google Webfonts, Google Maps, and external Video providers. Since these providers may collect personal data like your IP address we allow you to block them here. Please be aware that this might heavily reduce the functionality and appearance of our site. Changes will take effect once you reload the page.
(FXC)
