Complications
By Yiannis G. Mostrous
MCLEAN, Va.–In the March 8 SRI, Hedge Your Bets, I wrote:
The latter prediction materialized, while the jury’s still out on the former. Although I’ll eventually provide a more detailed 2007 forecast, recent data suggest the possibility of a US recession next year has increased. And as has been noted here before, expect the slowdown to begin in the second half of 2006.
As a matter of investment approach SRI usually avoids dedicating a lot of time to short-term market gyrations. But given the current global selloff in equities and the fact that many commentators have resurfaced with their usual “I told you so” arguments, it’s necessary to address the prevailing issues and to revisit SRI’s short-term approach.
In the aforementioned March 8 issue, I presented a chart of a ratio used to asses the forecasting of tactical (i.e., short-term) market moves. As I wrote then, when the ratio falls below the support level of 1.3, the risk for a selloff increases. The chart below depicts the movements of the ratio since March 8.
Bloomberg
Since then, emerging markets–where the selloff has been concentrated–proceeded to lose 18 percent in US dollar (USD) terms.
The same ratio is now sitting at a longer-term support level and a brake below that could exacerbate the selloff. I admit having no insight on that one, but things aren’t looking very promising, at least not yet.
Bloomberg
The market is still undecided if it’s inflation or the lack of growth it should most worry about. It’s obvious, of course, that an inflation scare will further damage the markets (see SRI, 7 June 2006, No Growth Wanted). And this is the main complication to the fairly benign view of the current selloff, namely that it is–for the time being–a forced liquidation of overleveraged positions.
As an aside, in conversations with long-only managers, I’ve learned that many of them haven’t started selling yet; they’re nervous, to say the least. The obvious risk here is a wave of redemptions that could force these managers to sell, thus making the current correction a nastier one.
And yet some odd things are taking place. For starters, the Federal Reserve seems poised to raise rates again, as officials there continue to voice their concerns regarding the rise of core inflation. But bonds–not the most inflation-friendly investments–have been holding their own during the past six weeks. As the chart below depicts, government bonds have had their strongest performance this year, commencing around the same time the current correction in equities started.
Bloomberg
While emerging markets are getting killed, their currencies haven’t really followed. Although they’ve fallen a touch, not many have reacted as one might have expected based on past experience. The Thai Baht has lost some value against the dollar (you now need 38.5 Baht to buy 1 USD), but it’s nothing drastic, and most certainly not a violent move, at least for now.
Bloomberg
As a matter of fact, emerging currencies haven’t fared much worse than major currencies against the USD. The following chart depicts the USD against the select foreign currencies (the higher the ratio, the stronger the USD).
Bloomberg
It’s na’ve, of course, to try and suggest any kind of long trade with conviction in a market like this, but I’ll venture down that path nonetheless. Here are some suggestions, based on the SRI Portfolio, for readers who want to commit some capital on a long-term basis. (Note that the views on India discussed last week remain in place.)
Japan is the best bet for a good performance in the second half of the year, compared not only to emerging markets but to developed ones as well. Although more beta could be added to the Japan stocks in the Portfolio, I’ll refrain from doing so now.
Japan’s corporate sector is stepping up investment spending. Machinery orders increased by 12.2 percent year-over-year, much more than expected, confirming the investment upswing that’s now well underway.
Bloomberg
As noted here on numerous occasions, my expectation is that growth will continue as the Japanese economy gradually moves out of deflation while consumers return in strength, thus allowing Japanese firms more pricing power. SRI also expects 2007 to be the year that Japan’s GDP growth surpasses that of the US and the EU.
Furthermore, the yen will perform well this year and next. The currency has been fairly volatile, but, as the chart below shows, it’s been strengthening against the dollar. Expect this to continue at a gradual pace. It should come as no surprise if, by the end of the year, the yen trades closer to 100 yen per dollar. Expect the yen to break the 100 yen per dollar barrier in 2007. The chart below reports the number of yen per US dollar (a lower number means a stronger yen).
Bloomberg
Singapore is also a good place to commit some fresh money. Singapore runs a conservative fiscal policy and its market offers a good yield. I expect further appreciation of the Singapore dollar versus the USD, which will also help US-based investors. Readers who want to diversify away from the USD and the euro–and have the flexibility to do so–should consider buying the Singaporean dollar as it’s one of the most respectable paper currencies around. This is a long-term diversification move.
Thailand is also an economy I really like, but the political turmoil has been affecting the market negatively. It’s unfortunate that the economic advances in Thailand are being held hostage by the capriciousness of an elitist group in Bangkok’s inner circle. The Portfolio’s only Thai recommendation, Bangkok Bank (OTC: BKKPF), has been a weak one. It’s only a small part of the Portfolio, but it’s the best way to gain exposure to Thailand.
Finally, Taiwan is a peculiar investment case, but the Chunghwa Telecom (NYSE: CHT) buy recommendation is perhaps one of the best long-term picks in the SRI Portfolio.
As previously noted,
That said, the current selloff could go on, hurting Asia much more than is currently expected. In particular, as discussed last issue, commodities still hold the key–they have to correct more. Otherwise the probability of a harder landing would be dramatically increased.
Given my current views regarding bonds–and SRI’s long-held position that the final outcome in the US will be deflationary in nature–it’s no surprise that the hedging position on US government paper initiated here in March is still recommended. Use the iShares Lehman 7-10 Year Treasury Bond Fund (AMEX: IEF).
Treat this as a more permanent hedge for the Portfolio because, later in the year, this hedge will become important for better returns. As previously explained (see SRI, 15 February 2006, The Rules Of Engagement), hedges will be monitored separately since the Portfolio is a long-only portfolio.
The short recommendations of BHP Billiton (NYSE: BHP) and iShares MSCI Brazil ETF (NYSE: EWZ) are still working. Last week I recommended setting the stops to start capturing some profits and we will do the same this week. Set the stop at 42 for BHP and 37 for the iShares MSCI Brazil ETF.
MCLEAN, Va.–In the March 8 SRI, Hedge Your Bets, I wrote:
The thinking here remains the global economy will perform decently this year, although a US recession in 2007 can’t be ruled out. Yet, there are some signs that many markets around the world are due for a correction.
The latter prediction materialized, while the jury’s still out on the former. Although I’ll eventually provide a more detailed 2007 forecast, recent data suggest the possibility of a US recession next year has increased. And as has been noted here before, expect the slowdown to begin in the second half of 2006.
As a matter of investment approach SRI usually avoids dedicating a lot of time to short-term market gyrations. But given the current global selloff in equities and the fact that many commentators have resurfaced with their usual “I told you so” arguments, it’s necessary to address the prevailing issues and to revisit SRI’s short-term approach.
In the aforementioned March 8 issue, I presented a chart of a ratio used to asses the forecasting of tactical (i.e., short-term) market moves. As I wrote then, when the ratio falls below the support level of 1.3, the risk for a selloff increases. The chart below depicts the movements of the ratio since March 8.
Bloomberg
Since then, emerging markets–where the selloff has been concentrated–proceeded to lose 18 percent in US dollar (USD) terms.
The same ratio is now sitting at a longer-term support level and a brake below that could exacerbate the selloff. I admit having no insight on that one, but things aren’t looking very promising, at least not yet.
Bloomberg
The market is still undecided if it’s inflation or the lack of growth it should most worry about. It’s obvious, of course, that an inflation scare will further damage the markets (see SRI, 7 June 2006, No Growth Wanted). And this is the main complication to the fairly benign view of the current selloff, namely that it is–for the time being–a forced liquidation of overleveraged positions.
As an aside, in conversations with long-only managers, I’ve learned that many of them haven’t started selling yet; they’re nervous, to say the least. The obvious risk here is a wave of redemptions that could force these managers to sell, thus making the current correction a nastier one.
And yet some odd things are taking place. For starters, the Federal Reserve seems poised to raise rates again, as officials there continue to voice their concerns regarding the rise of core inflation. But bonds–not the most inflation-friendly investments–have been holding their own during the past six weeks. As the chart below depicts, government bonds have had their strongest performance this year, commencing around the same time the current correction in equities started.
Bloomberg
While emerging markets are getting killed, their currencies haven’t really followed. Although they’ve fallen a touch, not many have reacted as one might have expected based on past experience. The Thai Baht has lost some value against the dollar (you now need 38.5 Baht to buy 1 USD), but it’s nothing drastic, and most certainly not a violent move, at least for now.
Bloomberg
As a matter of fact, emerging currencies haven’t fared much worse than major currencies against the USD. The following chart depicts the USD against the select foreign currencies (the higher the ratio, the stronger the USD).
Bloomberg
It’s na’ve, of course, to try and suggest any kind of long trade with conviction in a market like this, but I’ll venture down that path nonetheless. Here are some suggestions, based on the SRI Portfolio, for readers who want to commit some capital on a long-term basis. (Note that the views on India discussed last week remain in place.)
Japan is the best bet for a good performance in the second half of the year, compared not only to emerging markets but to developed ones as well. Although more beta could be added to the Japan stocks in the Portfolio, I’ll refrain from doing so now.
Japan’s corporate sector is stepping up investment spending. Machinery orders increased by 12.2 percent year-over-year, much more than expected, confirming the investment upswing that’s now well underway.
Bloomberg
As noted here on numerous occasions, my expectation is that growth will continue as the Japanese economy gradually moves out of deflation while consumers return in strength, thus allowing Japanese firms more pricing power. SRI also expects 2007 to be the year that Japan’s GDP growth surpasses that of the US and the EU.
Furthermore, the yen will perform well this year and next. The currency has been fairly volatile, but, as the chart below shows, it’s been strengthening against the dollar. Expect this to continue at a gradual pace. It should come as no surprise if, by the end of the year, the yen trades closer to 100 yen per dollar. Expect the yen to break the 100 yen per dollar barrier in 2007. The chart below reports the number of yen per US dollar (a lower number means a stronger yen).
Bloomberg
Singapore is also a good place to commit some fresh money. Singapore runs a conservative fiscal policy and its market offers a good yield. I expect further appreciation of the Singapore dollar versus the USD, which will also help US-based investors. Readers who want to diversify away from the USD and the euro–and have the flexibility to do so–should consider buying the Singaporean dollar as it’s one of the most respectable paper currencies around. This is a long-term diversification move.
Thailand is also an economy I really like, but the political turmoil has been affecting the market negatively. It’s unfortunate that the economic advances in Thailand are being held hostage by the capriciousness of an elitist group in Bangkok’s inner circle. The Portfolio’s only Thai recommendation, Bangkok Bank (OTC: BKKPF), has been a weak one. It’s only a small part of the Portfolio, but it’s the best way to gain exposure to Thailand.
Finally, Taiwan is a peculiar investment case, but the Chunghwa Telecom (NYSE: CHT) buy recommendation is perhaps one of the best long-term picks in the SRI Portfolio.
As previously noted,
When investors think of Taiwan, they think of a high-beta, technology-oriented stock market. Although this isn’t wrong, many people miss the fact that Taiwan remains a political market–political in the sense that until the unification issue is resolved, there will always be a “lid” restraining Taiwan’s economic growth. (For more on the issue, see Geopolitics & Investing Quarterly, which provides a clearer picture of the situation and the area’s potential outcomes.)
Once the political issues are addressed, Taiwan’s market will decisively move higher. This is what makes Taiwan a riskier place, not its technology-heavy market.
That said, the current selloff could go on, hurting Asia much more than is currently expected. In particular, as discussed last issue, commodities still hold the key–they have to correct more. Otherwise the probability of a harder landing would be dramatically increased.
Given my current views regarding bonds–and SRI’s long-held position that the final outcome in the US will be deflationary in nature–it’s no surprise that the hedging position on US government paper initiated here in March is still recommended. Use the iShares Lehman 7-10 Year Treasury Bond Fund (AMEX: IEF).
Treat this as a more permanent hedge for the Portfolio because, later in the year, this hedge will become important for better returns. As previously explained (see SRI, 15 February 2006, The Rules Of Engagement), hedges will be monitored separately since the Portfolio is a long-only portfolio.
The short recommendations of BHP Billiton (NYSE: BHP) and iShares MSCI Brazil ETF (NYSE: EWZ) are still working. Last week I recommended setting the stops to start capturing some profits and we will do the same this week. Set the stop at 42 for BHP and 37 for the iShares MSCI Brazil ETF.