T-Minus Two Days
By Yiannis G. Mostrous
ATHENS, Greece–The time has come. In two days–and if not then, probably in August–the Bank of Japan (BoJ) is expected to end its zero interest rate policy (ZIRP). And every talking head–myself included–has his or her own interpretation of the significance of ZIRP’s end, as well as that of the policy of quantitative easing that preceded it.
Quantitative easing led to a contraction of Japan’s monetary base. The chart depicting this move is perhaps one of the most-referenced in the financial press as well as the independent research community. This is so for two reasons. It helps explain, conveniently and neatly, the current selloff in equity markets–especially emerging ones–and it offers a nice, scary picture.
GaveKal Research was, to my knowledge, the first group to posit the idea that BoJ tightening would be extremely harmful to global asset prices. Given GaveKal’s prestige, investors and commentators around the world got extremely comfortable with that explanation as it offers all the answers.
My view certainly isn’t as neat.
Although it’s obvious that Japanese liquidity has helped global asset inflation through various carry trades, that the country’s tightening can impact global prices to the degree contemplated is far-fetched. These same policies never helped the Nikkei before either. It’s an interesting theory, but it’s more convenient than convincing.
Furthermore, were the GaveKal correct, the massive repatriated funds (arising from Japanese investors cutting their losses abroad) as well as the liquidation of short yen carry trades by hedge funds would have strengthened the Japanese currency. And yet the opposite happened.
As the chart below depicts, the yen started losing ground right around the time that the global selling in equities commenced. Note that the chart shows yen per US dollar, so if it advances, the yen is losing ground. (It costs more yen to buy one US dollar.)
Source: Bloomberg LP
To be sure, my view isn’t that the end of ZIRP will have no further effect on financial markets; investors will have to come to grips with the new reality. The point to note is that, from a serious long-term perspective, Japan is indicating that it now feels comfortable returning to a normal monetary policy, one that will allow its central bank to more effectively manage future economic growth.
Short-term market volatility aside, for long-term bulls on the nation’s economy, Japan’s confidence and its exit from deflation is all that matters. Normalization of rates increases the alternatives available to the Japanese to use their huge bank deposits in more productive and profitable ways. And as I’ve written previously, investors who don’t think Japan’s deflation years are over shouldn’t own Japanese stocks. (See SRI, 14 June 2006, Complications for more on Japan’s 2006 prospects.)
The debate between “inflationists” and “deflationists” continues. As regular readers are aware (see SRI, 3 May 2006, Still Going and 17 May 2006, Debating), my take is that, more than actual inflation, the global economy will face an inflationary scare. Consequently, I expect the final outcome to be deflationary.
For the time being, as the following chart of the Economic Cycle Research Institute’s (ECRI) future inflation gauge for the US shows, inflation expectations are receding. History shows that when the future inflation guage begins to roll over from elevated levels, it’s a good time to allocate funds to US Treasurys. Hence, my recommendation to buy iShares Lehman 7-10 Year Treasury Bond Fund (AMEX: IEF) as a hedge position still stands.
Source: Bloomberg LP
That’s not to say that the inflation argument lacks merit. It’s obvious from the credit expansion in recent years that there are inflationary pressures, particularly in the US, but in other parts of the world as well.
In the US, as is well-known by now, credit expansion is concentrated in the housing sector; real estate has been the main beneficiary of the extremely loose monetary policy of the recent past. Given that homes represent the major asset for the majority of heavily indebted US consumers, it’s easy to understand that a slowdown in the sector could negatively impact economic growth.
Investors must keep in mind that what counts is action, for the simple reason that the picture is almost never perfect. After all, no matter the prevailing market and/or economic situation, you can easily assemble data to make a positive or negative argument.
But as I’ve said on numerous occasions, waiting on the sidelines for the ultimate disaster never helped anyone. Quite the contrary–just ask the perma-bears who missed the bull market move that commenced in 2003. Play the game cautiously, and buy insurance for when this bad day comes. Gold bullion remains my standard recommendation for insurance.
Speaking of gold, the chart of the South African rand below clearly shows that the currency has been weakening. I expect this to continue, so it’s a good idea to buy some South African gold and other commodity stocks–companies like Gold Fields (NYSE: GFI) and Harmony Gold Mining (NYSE: HMY).
Source: Bloomberg LP
The recent fireworks from North Korea had many investors thinking and many policy makers running around at a frenetic pace. I commented briefly last week, but a little more perspective is warranted.
Although no one can be certain about China, the fact is that Russia isn’t very happy with North Korea’s actions. Russia, although not ready to outright condemn the nation, is unhappy and is pushing North Korea–and China–for a credible solution.
The issues with North Korea are quite complicated, but there are some clearly identifiable facts. All and all, Kim Jong Il needs a little more than USD1 billion per year to keep the elite happy and, therefore, himself in power. Counterfeiting, the sale of maritime products, and gold and contribution from North Koreans living abroad provide the necessary funds. “Dear Leader” has been rumored to have personal assets stashed around the world totaling USD4 billion.
North Korea has been able to produce missiles since the early 1990s (and helped Pakistan build weapons that nation has used against India in the past). Despite the fact that the capabilities exist, many observers were encouraged by the fact that the last missile fired–most probably a Taepodong 2–fell 45 seconds into its flight. Consequently, they argue, North Korea isn’t as advanced as the West believes.
This is a very dangerous assumption; no one knows whether or not the North Koreans aborted the last launch after they saw a successful previous test. Bear in mind also that the aborted missile was already 200 miles away. The problem with this theory–although it can’t be discarded altogether–is that the US may be able to retrieve the missile.
That said, my view is that Kim Jong Il isn’t very popular among the elite right now; there are reports indicating the imprisonment of former friends and defections of rich, upper-class North Koreans. He could be trying some new tricks to show that he’s still in control. His actions could also be interpreted as an effort to “manage tensions” until North Korea is ready for a nuclear test of some sort.
Though Japan has been at the forefront demanding UN action, the US response is most critical. The US and China will have the last word on the North Korea issue.
Many in the US have suggested bombing the launch site because it’s stationary and easy to hit. But such an action is unlikely to solve anything, and it could create more problems. A more interesting approach that’s been floated is interception.
The idea is fairly simple. Satellite intelligence makes it very easy to see when the North Koreans are ready to launch. At the same time, the US has the capability to not only intercept a missile, but to do it without being detected. If this idea has been discussed seriously within the Bush administration–and my information is that it has–then there’s reason to suspect the last North Korean missile was intercepted. Will we ever really know?
When all is said and done, North Korea is a problem that’s increasingly becoming a big nuisance for China and the rest of the world. It’s conceivable that the Chinese will eventually push for a more permanent solution, instead of putting their economic growth in danger.
Speaking of danger, the recent train bombings in Mumbai, India, serve as a reminder that the world hasn’t necessarily become a safer place. And since there’s a strong possibility that the guilty parties will be found to have some connection with India’s neighbors in the north, these bombings will eventually put the US/Indian relationship under a different prism.
The US has shown a lot of affection for Pakistan, a country that’s viewed–and rightfully so–as a source of regional destabilization, given its almost complete lack of economic capabilities and its status as an economic-aid junky.
That said, the recent events won’t derail Indian economic growth, which is still questioned by pro-Chinease/East Asia US-based analysts on grounds that would inspire a child’s skepticism.
I’ll have more on India in a future issue.
Portfolio Talk
This issue I’m selling NIDEC out of the SRI Portfolio. The stock has been disappointing, but above all, it’s export-oriented; right now my view is that Mitsubishi Heavy Industries is a better long-term, export-oriented bet. Sell NIDEC.
Finally, I’m looking to add more beta to the Portfolio, probably from Europe. The idea is that if there’s no recession after the US Federal Reserve is done tightening, there will be some profits to be had if you invest in the right sectors.
ATHENS, Greece–The time has come. In two days–and if not then, probably in August–the Bank of Japan (BoJ) is expected to end its zero interest rate policy (ZIRP). And every talking head–myself included–has his or her own interpretation of the significance of ZIRP’s end, as well as that of the policy of quantitative easing that preceded it.
Quantitative easing led to a contraction of Japan’s monetary base. The chart depicting this move is perhaps one of the most-referenced in the financial press as well as the independent research community. This is so for two reasons. It helps explain, conveniently and neatly, the current selloff in equity markets–especially emerging ones–and it offers a nice, scary picture.
GaveKal Research was, to my knowledge, the first group to posit the idea that BoJ tightening would be extremely harmful to global asset prices. Given GaveKal’s prestige, investors and commentators around the world got extremely comfortable with that explanation as it offers all the answers.
My view certainly isn’t as neat.
Although it’s obvious that Japanese liquidity has helped global asset inflation through various carry trades, that the country’s tightening can impact global prices to the degree contemplated is far-fetched. These same policies never helped the Nikkei before either. It’s an interesting theory, but it’s more convenient than convincing.
Furthermore, were the GaveKal correct, the massive repatriated funds (arising from Japanese investors cutting their losses abroad) as well as the liquidation of short yen carry trades by hedge funds would have strengthened the Japanese currency. And yet the opposite happened.
As the chart below depicts, the yen started losing ground right around the time that the global selling in equities commenced. Note that the chart shows yen per US dollar, so if it advances, the yen is losing ground. (It costs more yen to buy one US dollar.)
Source: Bloomberg LP
To be sure, my view isn’t that the end of ZIRP will have no further effect on financial markets; investors will have to come to grips with the new reality. The point to note is that, from a serious long-term perspective, Japan is indicating that it now feels comfortable returning to a normal monetary policy, one that will allow its central bank to more effectively manage future economic growth.
Short-term market volatility aside, for long-term bulls on the nation’s economy, Japan’s confidence and its exit from deflation is all that matters. Normalization of rates increases the alternatives available to the Japanese to use their huge bank deposits in more productive and profitable ways. And as I’ve written previously, investors who don’t think Japan’s deflation years are over shouldn’t own Japanese stocks. (See SRI, 14 June 2006, Complications for more on Japan’s 2006 prospects.)
The debate between “inflationists” and “deflationists” continues. As regular readers are aware (see SRI, 3 May 2006, Still Going and 17 May 2006, Debating), my take is that, more than actual inflation, the global economy will face an inflationary scare. Consequently, I expect the final outcome to be deflationary.
For the time being, as the following chart of the Economic Cycle Research Institute’s (ECRI) future inflation gauge for the US shows, inflation expectations are receding. History shows that when the future inflation guage begins to roll over from elevated levels, it’s a good time to allocate funds to US Treasurys. Hence, my recommendation to buy iShares Lehman 7-10 Year Treasury Bond Fund (AMEX: IEF) as a hedge position still stands.
Source: Bloomberg LP
That’s not to say that the inflation argument lacks merit. It’s obvious from the credit expansion in recent years that there are inflationary pressures, particularly in the US, but in other parts of the world as well.
In the US, as is well-known by now, credit expansion is concentrated in the housing sector; real estate has been the main beneficiary of the extremely loose monetary policy of the recent past. Given that homes represent the major asset for the majority of heavily indebted US consumers, it’s easy to understand that a slowdown in the sector could negatively impact economic growth.
Investors must keep in mind that what counts is action, for the simple reason that the picture is almost never perfect. After all, no matter the prevailing market and/or economic situation, you can easily assemble data to make a positive or negative argument.
But as I’ve said on numerous occasions, waiting on the sidelines for the ultimate disaster never helped anyone. Quite the contrary–just ask the perma-bears who missed the bull market move that commenced in 2003. Play the game cautiously, and buy insurance for when this bad day comes. Gold bullion remains my standard recommendation for insurance.
Speaking of gold, the chart of the South African rand below clearly shows that the currency has been weakening. I expect this to continue, so it’s a good idea to buy some South African gold and other commodity stocks–companies like Gold Fields (NYSE: GFI) and Harmony Gold Mining (NYSE: HMY).
Source: Bloomberg LP
The recent fireworks from North Korea had many investors thinking and many policy makers running around at a frenetic pace. I commented briefly last week, but a little more perspective is warranted.
Although no one can be certain about China, the fact is that Russia isn’t very happy with North Korea’s actions. Russia, although not ready to outright condemn the nation, is unhappy and is pushing North Korea–and China–for a credible solution.
The issues with North Korea are quite complicated, but there are some clearly identifiable facts. All and all, Kim Jong Il needs a little more than USD1 billion per year to keep the elite happy and, therefore, himself in power. Counterfeiting, the sale of maritime products, and gold and contribution from North Koreans living abroad provide the necessary funds. “Dear Leader” has been rumored to have personal assets stashed around the world totaling USD4 billion.
North Korea has been able to produce missiles since the early 1990s (and helped Pakistan build weapons that nation has used against India in the past). Despite the fact that the capabilities exist, many observers were encouraged by the fact that the last missile fired–most probably a Taepodong 2–fell 45 seconds into its flight. Consequently, they argue, North Korea isn’t as advanced as the West believes.
This is a very dangerous assumption; no one knows whether or not the North Koreans aborted the last launch after they saw a successful previous test. Bear in mind also that the aborted missile was already 200 miles away. The problem with this theory–although it can’t be discarded altogether–is that the US may be able to retrieve the missile.
That said, my view is that Kim Jong Il isn’t very popular among the elite right now; there are reports indicating the imprisonment of former friends and defections of rich, upper-class North Koreans. He could be trying some new tricks to show that he’s still in control. His actions could also be interpreted as an effort to “manage tensions” until North Korea is ready for a nuclear test of some sort.
Though Japan has been at the forefront demanding UN action, the US response is most critical. The US and China will have the last word on the North Korea issue.
Many in the US have suggested bombing the launch site because it’s stationary and easy to hit. But such an action is unlikely to solve anything, and it could create more problems. A more interesting approach that’s been floated is interception.
The idea is fairly simple. Satellite intelligence makes it very easy to see when the North Koreans are ready to launch. At the same time, the US has the capability to not only intercept a missile, but to do it without being detected. If this idea has been discussed seriously within the Bush administration–and my information is that it has–then there’s reason to suspect the last North Korean missile was intercepted. Will we ever really know?
When all is said and done, North Korea is a problem that’s increasingly becoming a big nuisance for China and the rest of the world. It’s conceivable that the Chinese will eventually push for a more permanent solution, instead of putting their economic growth in danger.
Speaking of danger, the recent train bombings in Mumbai, India, serve as a reminder that the world hasn’t necessarily become a safer place. And since there’s a strong possibility that the guilty parties will be found to have some connection with India’s neighbors in the north, these bombings will eventually put the US/Indian relationship under a different prism.
The US has shown a lot of affection for Pakistan, a country that’s viewed–and rightfully so–as a source of regional destabilization, given its almost complete lack of economic capabilities and its status as an economic-aid junky.
That said, the recent events won’t derail Indian economic growth, which is still questioned by pro-Chinease/East Asia US-based analysts on grounds that would inspire a child’s skepticism.
I’ll have more on India in a future issue.
Portfolio Talk
This issue I’m selling NIDEC out of the SRI Portfolio. The stock has been disappointing, but above all, it’s export-oriented; right now my view is that Mitsubishi Heavy Industries is a better long-term, export-oriented bet. Sell NIDEC.
Finally, I’m looking to add more beta to the Portfolio, probably from Europe. The idea is that if there’s no recession after the US Federal Reserve is done tightening, there will be some profits to be had if you invest in the right sectors.