5 September 2010

Stability Returns

Last week has clearly brought some stability back to the markets.  Perhaps its the start of school, return home, return to reality.

This is actually good news, as reality usually does not mean terrible, or wonderful, but simply somewhere in the middle.

Interestingly however, the news, especially on employment (bad, but not as bad as expected) where not that good.  Indeed the news appears to be the good example of expectations management.  The terrible August has led number of economists to change their forecasts downwards, to be in line with the risk of double dip (just in case you don't know our views yet, economists are always in line with the mainstream views).  This change of expectations was however not needed to such magnitude, and hence when the actual numbers came out the market (stupid as it is) has reacted positively, as the news were not as bad as expected (though expectations were clearly skewed in the first place).

Double Dip

When talking to clients a lot of them asked me about Double Dip.  Clearly they are concern, concerned for their businesses, investments, well being.  Often potentially already well off their best days, their margins for error are much smaller, and they want to know if we should expect things to worsen or not.  Why do I tell you this... well because importantly the business talks about Double Dip out of fear of worsening of the situation, and not in context of deciding if they should invest more.  This is clearly not a good sign.

However I also have a problem with discussing the double dip with them, and anyone actually. People treat double dip as some sort of decisive factor, instinctively thinking that double dip means trouble, and no double dip means good.  Well this notion needs to be corrected.

Yes, the double dip is priced in at some 20%. Yes Shiller says that the risk of Double Dipis 50%, Roubini is at 40% (its very interesting to read his views especially, as he is basically advocating that we are in liquidity trap).  Now, I personally do not think there will be a double dip at all, and it would require a government failure of mass magnitude for me to be proved wrong (though some countries will experience it).  It is my believe that if needed governments will print so much cash, that we will be more likely to end up like Zimbabwe then face the double dip. Nobody wants the recession, nobody benefits from the recession.  People (albeit some) benefit from the situation in Zimbabwe (poor people of course and in the short term the government).

So while I personally do not think that there will be a Double Dip, I do think that the economy is in dire straits, full of structural problems, unemployment, spare human capacity (lets face it, most people out there, and many from the "lost generation" have only one skill, and that is of consumption.  For instance I would love to see their Relative Comparative Advantage (old good Adam Smith), when comparing US 20 year old kid, to that of Chinese 20 year old kid.  Things are hence likely to turn wrong before they start to turn right.  It might take a generation to change things around, and some truly extraordinary events, such as emergence of new era of colonialism (natural resources and internet), discovery of ground breaking free power technology (soon).  Otherwise, we are in for a long wait for things to naturally stabilize, for the catch up effect of China and EM to take place.


This week in Poland we got asked a few questions on PLN rate, and while on Double Dip the answer was clear, this question is actually very very difficult for us to answer.

This is what will happen:

1) economies will print more and more money... Fed, BoE, ECB, subsequently Chinese, other Asian countries.  Everyone is pegging vs dollar, and everyone wants to remain competitive.

2) Poland, I fear, is in position where even if every other central bank is printing money, it might not be able to print the money itself.  Not because it would be wrong to do, but because it has no framework to do it.  Look, it took a weekend of negotiations for EU to decide on the structure on how to do do QE to help the Greeks, and in future possibly the other PIGS (you might not like this phase... but its real, and linked to first letters - just as BRIC).  So, my feeling is, that while everyone prints, Poland will not, leading to the appreciation of the currency.

Another element that should be looked at is the simple old fashioned, but since 2007 out of favour, Balassa-Samuleson effect, which basically states that due to increases in EM productivity, the EM currencies will appreciate too.  Indeed it is my believe that after the totally unpredictable almost chaos recession of 2008- 2009, we should not look back to basics, remember the old fashioned economics, and slowly start to prepare for the return of normality....   not just new-normal... but plain simple rationality.

Summary:  what to invest in?

EM:  Overall EM will be the winners in the New World Order, thanks to catch up effect, productivity gains, continuing impact of globalisation.

Some words of caution though: 

    - fx is easier to invest in, then equities (local equities are often illiquid, and already overvalued + risk of classis EM problems like "strategic defaults" and other issues)

    - be careful in defining what EM is - as EM is a relative value... so for instance Central Europe is a good example of Emerging Markets of EU, and China + SE Asia is a good example of the global Emerging Market... but on the other hand Congo is not really an EM of anything at the moment).

    - while the the risks of speculative attacks on the specific countries is so much smaller now (decreased leveraged, Volcker rule, etc), yet there are still countries that are at risk of the debt crisis, as they are - just as the rest of the world - in need of its refinancing.  Look at foreign debt trading ratio.  Be innovative, but fundamental in your approach.

And of course:  scarce resources. London will be London, New York will not grow.  Hollywood culture will not change (if anything it will grow more).   Maldives will not get new islands (did you see my Private Maldives Island Offer?).  Invest into things that are very scarce and practical.  Look at valuations of course, but focus on scarcity.

Other asset classes

Commodities:  yes, as they are also scarce.

Equities:  seem overvalued for some time now, but like many I still think that they are better then cash.

Cash and Fixed Income:   the tightening bond spreads show me that this Chaos of 2008 - 2009 is still not entirely absent.  Flight to quality as a concept is to me a classic trading idea, especially that as with identification of EM, we should focus on the "quality" element (which ironically i very very scarce right now - as the logic would suggest that it should be).