Something is Cooking – Beyond QE ‘Infinity’
Thank you to GSAM’s Sam Finkelstein for his contribution to my title this week. This is his way of describing what the Fed unleashed on the world markets last night. In conjunction with the bold steps made by the ECB, these two policy drivers alone are enough to force some of the more miserable-minded investors out there to pause and possibly adjust their mindsets to a less cataclysmic view of the world. But these aren’t the only important things going on. In two of my beloved BRIC countries, Brazil and India, there are signs of positive policy and supply-side developments appearing.
All of this is against the background of highly undervalued equity markets in many parts of the world. This is based on very conservative, long term, cyclically-adjusted PE or CAPE ratios (see the attached, especially column 4). It strikes me that us relatively-lone bulls are not going to remain quite so lonely.
Anyhow, lots to discuss.
Fed Sends Powerful Message.
So, I have to admit I somewhat misinterpreted Bernanke at Jackson Hole. I thought he was setting out a conceptual framework for the Fed being able to do plenty more quantitative easing in the future, laying out the costs versus gains. But we now know that it was a pretty clear message about what the Fed was going to do. In essence, and hence Sam Finkelstein’s phrase, the Fed appears to have shifted the balance of its previous twin mandate and prioritised reducing unemployment quickly. As many people have emailed me to ask, there are clearly plenty of risks with what the Fed is doing. However, whilst long-term inflation expectations remain subdued, hats off to them and congratulations. In my view, having rising inflation as a more genuine risk would not be that unwelcome a problem to deal with. So for the foreseeable future, every Thursday’s weekly job claims and each first Friday’s payrolls and unemployment data take on even more importance. Plain and simple.
An alternative way of thinking about the Fed’s move is as a move down the path towards ‘nominal GDP’ targeting. This will get even more media coverage than the coverage post the Jackson Hole speech. Importantly, in this context, the FOMC revised their real GDP projections for the next three years higher – yes, higher.
Other Interesting Things Regarding the US.
I read a fascinating story in the FT on Wednesday 2nd September entitled “US rail groups track shale boom”. The article sums up a couple of the key medium-term forces, which warrant a more optimistic stance on the US. The piece includes a great chart showing the explosive growth of crude oil being carried by rail.
It is also interesting that some of the ratings agencies are starting to make noises about the need for something credible regarding the dreaded fiscal cliff. Of course this is necessary and something that we should expect. As I have said before, it is not inconceivable at some stage that attention shifts to DC on such matters, possibly in 2013 and only when this Euro mess finally disappears off the radar.
A Trip to Stockholm.
I made my first plane trip in 12 weeks this week, which is probably some kind of record for the past 20 years or more. It was bliss, but not something that would last. A 24-hour sojourn to sunny Stockholm was a rather nice way to ease back in to the manic travel that lies ahead. When I returned to Heathrow, there was no queue whatsoever and I teased the passport control guys that I hadn’t realized the Olympics were still on…
We were hosting our annual GSAM Nordic client conference. This year we asked clients to vote on a number of questions. I asked three. First, will the S&P be higher or not by year-end 2012? 55% said yes. Second, do you believe the Euro is going to survive? 64% said yes. And third, do you think Chinese consumption is going to become more important? A high 70% said yes. More on that below.
As well as presenting my views to this group, I also visited a couple of other clients and enjoyed a wonderful dinner with a good friend of mine. Across the board, China was the most frequent topic raised. People varied from being worried, to excited, to just simply being intrigued about the place.
It was interesting being in Sweden after the sharp rally in the Kroner. I joked to some people, after spending the best part of the past decade wondering why the currency was so undervalued for so long, here it is back in the vicinity of fair value. A comforting take away for persistent Yen bears and shorts of recent years – add Sweden to the list of countries that don’t really want a stronger currency anymore.
The UK. Anecdotal Improvements.
The UK published another better-than-expected employment report this week, adding to the recent run of positive data, and again questioning the prevailing view of recession.
Every now and then, usually on a Saturday morning, I occasionally wander around our south west neighbourhood of London and count the number of vacant shops in the two main shopping areas. I hadn’t done it for months and when I had done it during the past couple of years, it was generally in the vicinity of six to eight in both streets. This time it was just one and three, the lowest since the issue became of relevance. Whether this is ‘back to school’ or not, I am not sure, but I found this rather encouraging. We also encountered a rather amusing anecdote about the shopping activities of a member of government but it would be most unfair to talk about that…
Late last week, I participated in a panel about global governance at the Bruegel annual conference. There were other interesting sessions especially coming the day after the ECB meeting. The mood was quite cheerful and full of support, which is not surprising given what Bruegel represents.
Beyond the chatter about Draghi’s bold steps and the fact that Merkel had backed him and not the Bundesbank, it seems to me that the mood around a couple of other critical topics is improving.
In addition to demonstrating his ability to be a strong leader of the ECB, Draghi is a key part of the ‘gang of four’ who are working on a detailed plan for ‘more Europe’. This includes thoughts about how to make the EMU more accountable and representative, as well as tuned in to Europe’s voters. It is against this background that one should think about the ECB’s recent announcements for potential bond buying. There is a strong desire for ‘more Europe’, despite some of the obvious challenges.
In this spirit, it seems to me more and more, that Germany has had a clear change of mind about a ‘Grexit’ and there is no desire to push Greece out these days. In fact, I hear growing acknowledgement that some Greek policies are starting to bear fruit, especially relative unit labour costs. Markets are taking note, as Greek assets have seen a particularly strong rally this week.
It is starting to dawn on more and more observers that quite a few ‘Club Med’ countries that were widely believed to be incapable of adjusting, are in fact showing signs of notable improvements in relative unit labour costs. This applies especially to Ireland, Spain and Portugal in addition to Greece.
It is also interesting in this context to see warm praise for Portugal coming from the IMF this week.
There are all sorts of things that might upset the apple cart in Europe still; not least the little matter of a growing independence mood in Catalonia. This might make the timing of any Spanish request of ESM/ECB support even trickier, but the underlying tone is better.
In this context, it is quite interesting, albeit perhaps a bit premature, to note that there is modest improvement in the tone of some of the Euro area data, including the latest IP numbers.
BRICs, N-11 et Al.
Despite the ongoing turmoil and volatility in the Middle East, I have noticed a distinct uplift in some of the media coverage about Egypt. The FT recently even ran a story entitled “Egyptian consumers lead the rise in optimism”.
More and more media and retail investors are getting excited about the ‘MIST’ group from our defined Growth Markets. MIST represents Mexico, Indonesia, South Korea and Turkey, four of the Next 11 countries that we regard as already progressed enough and shouldn’t be considered Emerging Markets. A number of people approach us about offering products related to MIST. I continue to reply that these four countries represent 75% of the N-11 index and that they should consider our N-11 products. Our products continue to attract money and contrary to the perceived notion that EM has been struggling, many of these countries are now up more than 20% year-to-date.
Brazil continues to chip away with supply-side policy changes. On Thursday they announced steps to try and lower energy costs as well as improving the tax environment. On top of other initiatives, I think justifies investors ignoring the recent disappointing slowdown. I increasingly think that it won’t last for long, and as often with Brazil, the mood has swung too far to the other side of reality. Brazil can still grow by 4-5% and I suspect, within a few months, that mood will be back.
India. We Never Really Hated it Did We?
As of this morning, the main Indian stock market is up nearly 20% for the year. There was a particularly good move this morning, accelerating the rise of recent weeks, which occurred despite all of India’s ‘disappointments’. Some of this was prompted by news that the authorities have finally had the courage to raise fuel taxes and reduce the subsidy. This indicates that; a) they now are prepared to do something about the growing fiscal deficit and b) they are capable of positive policy change.
Not surprisingly on the back of this, expectations are starting to rise that this is the first in a number of important supply-side policies that the coalition has finally decided to implement. This includes today’s talk of plans to try to encourage FDI into the retail industry once again. There is also talk that such steps are going to be announced in other areas too.
On Thursday evening, I had the honour of speaking at a dinner for Prabodhan, an EU Indian leaders ‘conclave’, ahead of a full day of discussions between senior business leaders, academics and policymakers from both the EU and India. After teasing them that one of the clear things that both have in common, is that investors dislike both equally and that also both manage to somehow frequently create crises when there is no real need for them, it is not difficult for policy to positively surprise. From the little chatter I had time to enjoy before the dinner, their timing seems to be good as it relates to the above and policy is on the “up” in both the EU and India. As I ended up saying at the dinner, it is still possible for India to enjoy years of 10%-type growth in the future, despite the new fashionable mood, driven by India’s spectacular degraphics.
It was a bit of an ‘India week’ for me as I also spoke at an important event for big real estate industry players on behalf of a fabulous Indian charity, the Akshaya Patra Foundation. I believe that the foundation is one of the largest NGOs in the world, and its main goal is to provide food and support for a vast rising number of Indian children in order to facilitate their education. This is the sort of thing that could really transform India, in conjunction with other slow-moving supply-side reforms.
Only One Topic to End With, China, Again.
In our monthly insight paper we lowered our official 2012 China GDP forecast to 7.4% and we worry that without some acceleration even that might be hard to achieve. We have kept our 2013 number at 8%, but we are still below consensus for both this year and next.
As I have said on a number of occasions regarding China, the market needs to a) forget all the 10% real GDP years, and b) stop thinking that there is a new infrastructure project around the corner.
At a number of my meetings this week, I explained that we are in the early days of a ‘new’ China which is all about ‘quality’ and not ‘quantity’. In this regard, while much of the August data releases were ‘disappointing’, to a government that has told us their five-year plan is based on achieving 7% real GDP growth, and 7.5% for this year, I don’t think they are too disappointed. The consensus sell side is still forecasting more than China’s own forecast for the year, that in itself might give the government some comfort.
Within the latest data, there was one important positive for you all to ponder. Retail sales actually rose slightly to 13.2% year-on-year. In my view, the performance of retail sales relative to industrial production (IP) is a simple guide to rebalancing and whether the government is moving down the path it has told us it wants to. This picture certainly supports it.
Having said this, there were clear disappointments in the data, especially about the ‘old’ China including weak IP. There was softer-than-expected or desired money supply and import data for both the ‘new’ and ‘old’ China, although bank lending picked up notably on the month.
The ‘new’ and more ‘quality’-focused China is all about sustaining consumption (although not just for the luxury goods industry), less about energy intensive and polluting production, such as alternatives and energy-efficient production and business and innovation. In this context, I had some other very interesting meetings this week, including one with a Chinese backed – although not Chinese – agrochemical company, this company epitomizes the ‘new’ China. My other meeting was with a solar energy research business of which the Chinese are major clients. One company is Middle Eastern and the other is Scandinavian.
A big development this week was the focus on global luxury brands following recent news and guidance in the sector. It led me to think whether heavy-commodity intensive companies are not the only casualty of the ‘new’ China but also
Big luxury winners of the past. Some weeks ago, the CEO of a niche Chinese jeweller that I invest in personally told me that he thought the future opportunity lies in what he refers to as “luxury lite”. This is consistent with the five-year plan. The big consumption story is the true middle classes, especially those genuine wage and income earners, and the days of big gifting are drawing to a close. I hear more and more of this and it is another sign of the ‘new’ China.
What is not a sign of the ‘new’ China is that the guy that is supposed to be the chosen one to preside over it has gone missing. Having read all the chatter about the supposed reasons, I find myself thinking two different things. Firstly, given how I understand China works in terms of economic policies, the leaders that rise to the top only do so as they have embraced the thrust of policy as designed by the five-year plan. In this sense, whoever the person is at the top probably doesn’t matter as much as many think. Secondly, in this day and age of such widespread media attention, the Chinese leadership simply cannot operate in the way they have done in the past, and it is not clear that this is yet understood. I have a sneaking feeling that this episode is going to result in accelerated changes, which oddly will enable the path to more ‘quality’ to be easier than otherwise. However, it might be a bit bumpy…
We released our monthly insight this week, and in it we tried to establish probabilities that markets are placing on really bad economic outcomes, especially on four well-discussed topics; an EMU break up, the US fiscal cliff, a China hard landing, and the Middle East and oil. In three of the four, we show the market probability is far too pessimistic (with the exception being the US topic). This, in addition to our ongoing assessment of more likely central developments, keeps us more optimistic about markets.
Now away from all of this, and helped by Bernanke on top of the ECB, there are signs of a positive market breakout all over the place, not least demonstrated in the chart of Greek equities attached.
And this weekend, the Premier League is back, what more could one want?