Give last week back to the In­di­ans

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

As Paulie Wal­nuts from the So­pra­nos would have said, “You can give last week back to the In­di­ans”, even though it is when vo­latil­ity spikes that in­vest­ment op­por­tu­ni­ties start to arise. In this spirit, and to take us away from ISIS, Ebola, Ukraine and what­ever other horse­men of the apoc­a­lypse the me­dia will fo­cus on next, we thought we would re­view the more im­por­tant macro-trend con­fir­ma­tions pro­vided by the mar­kets re­cently.

1) There is no ‘peak’ any­thing: what we have seen is a fairly nor­mal, if su­per-charged, com­mod­ity cy­cle. An in­vest­ment drought in new pro­duc­tion ca­pac­ity over 20 years from 1982 to 2002, com­bined with a surge in de­mand from 2002, led to a sup­ply short­fall in almost ev­ery com­mod­ity there is. The re­sult­ing jump in prices be­tween 2003 and 2008 trig­gered a boom in cap­i­tal spend­ing in the sec­tor, and a sig­nif­i­cant in­crease in sup­ply. Now, we have en­tered the long phase in which prices grad­u­ally grind down to­wards the mar­ginal cost of pro­duc­tion of the cheaper pro­duc­ers. In this sense, com­modi­ties are almost the po­lar op­po­site of eq­ui­ties: they take the el­e­va­tor up, and the stairs down again.

2) Eu­roland are slid­ing to­wards a de­fla­tion­ary bust: with the two most im­por­tant prices in an econ­omy (in­ter­est rates and ex­change rates) fixed, it is no sur­prise that the other two main vari­ables (as­set prices and em­ploy­ment) must ad­just to the world’s ac­cel­er­at­ing Schum­pete­rian forces. Any in­vestor bench­marked against the MSCI World, EAFE, or even Europe, is bet­ter off un­der­weight eu­roland eq­ui­ties, un­less (like Ja­panese stocks in the 1990s and 2000s) they be­come ei­ther a) ridicu­lously cheap, or b) an ob­vi­ous pol­icy cat­a­lyst is un­leashed.

3) China is do­ing what it has al­ways done: deal with a slow­down in its struc­tural growth rate by em­brac­ing fur­ther dereg­u­la­tion. After Deng Xiaop­ing dereg­u­lated China’s labour mar­kets in the early 1980s and cor­po­rate struc­tures in the early 1990s, after Zhu Rongji dereg­u­lated real es­tate and re­formed state en­ter­prises in the late 1990s, and after Hu Jin­tao and Wen Ji­abao dereg­u­lated com­mod­ity mar­kets a decade ago, Xi Jin­ping is con­fronting the fi­nal fron­tier: the dereg­u­la­tion of cap­i­tal. To a large ex­tent, this is hap­pen­ing through Hong Kong in the form of ren­minbi in­ter­na­tion­al­i­sa­tion, the cre­ation of the dim sum bond mar­ket and the Shang­hai-HK Stock Con­nect pro­gramme. This may help to ex­plain why the Chi­nese gov­ern­ment feels the need to en­sure that Hong Kong’s chief ex­ec­u­tive will al­ways be Beijing-friendly, a need which has led to the cur­rent street protests.

4) Ja­pan is do­ing what it has al­ways done: em­brac­ing mer­can­til­ism. What else does one call a pol­icy that on one hand con­strains do­mes­tic con­sump­tion with higher sales taxes, and on the other tries to boost ex­ports via cur­rency de­val­u­a­tion? Sure, one could call it ‘Abe­nomics’, but ‘mer­can­til­ism’ does just as well. And though fur­ther sales tax in­creases may now be on hold (see Shinzo Abe’s com­ments over the week­end), it is a safe bet that Tokyo re­mains set on de­valu­ing the yen fur­ther, un­til Ja­pan moves back into a trade sur­plus. After all, the last thing the Ja­panese want is to be­come in­creas­ingly de­pen­dent on for­eign­ers for debt fi­nanc­ing (es­pe­cially if-God for­bid-those for­eign­ers are likely to be Chi­nese). And if one doesn’t want to be­come de­pen­dent on for­eign­ers, one can­not af­ford to run a trade deficit.

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