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    Gavekal Research

    Not Letting A Good Crisis Go To Waste

    At the beginning of 2018, one of Gavekal’s big themes for the coming year was that the liquidity environment was deteriorating. Behind this we saw three causes: 1) the US Federal Reserve’s decision to shrink its balance sheet; 2) the growing toll of rising energy prices, and 3) the coming liquidity drain from runaway US government spending.

    2
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    Gavekal Dragonomics

    Marshals Over Markets: China Tightens Cybersecurity

    Our first DeepChina report takes a close look at Beijing's efforts to exert tighter control over the internet, the flow of commercial data, and the security of its technological infrastructure. China ia nor alone in toughening regulation, but its efforts are far more expansive, and raise more serious concerns for multinational firms.

    2
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    Gavekal Research

    The Hurdles For US Profits

    Corporate America shot the lights out in the first quarter as tax cuts helped S&P 500 earnings soar by 23%, while macro data released this week showed profits rising an aggregate 14% year-on-year, versus 4.8% in 2017. This week also saw good news for banks, as regulatory shackles were loosened. Yet investors who think US firms are headed back to the races must convince themselves that a series of late-cycle hurdles can be overcome.

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    Gavekal Research

    Strategy Monthly: Dollar + Oil + Political Risk = ?

    So far, 2018 has delivered a lot of volatility, and mediocre returns across almost all asset classes. Will the second half be any different? It's hard to sustain a high level of conviction given the resurgence of political risk. In the latest Strategy Monthly, we offer a way to think through investment decisions based on the direction of oil prices and the dollar.

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    Gavekal Research

    Video: Malaysia's Old Man In A Hurry

    In elections earlier this month, Mahathir Mohamad stunnned Malaysia, defeating the party he led for 20 years to become the country’s new prime minister. In this short video interview, Udith examines Mahathir’s policy platform, and asks whether the resurgent 92-year-old can really rejuvenate Malaysia’s economy.

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    Gavekal Dragonomics

    China Comes Off The Boil

    Chinese growth surprised on the upside in the early part of the year, but Andrew thinks that a gradual loss of altitude is now unfolding. This is mainly due to slowing property market activity, which increasingly displays late-cycle characteristics. This adjustment should not pose a major risk to other major economies, so long as other global factors do not become disruptive.

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    Gavekal Research

    Whether To Buy Italy (And The Euro)

    On Wednesday, Louis argued that the Italian president’s rejection of a proposed coalition finance minister was “worse than a crime, a mistake”. Anatole and Cedric are not so sure. In this paper they examine the two conditions—one political, one financial—that will signal a major buying opportunity in Italy.

    2
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    Gavekal Research

    Worse Than A Crime

    On hearing that Napoleon Bonaparte had ordered the execution of a Bourbon-family duke, the arch realpolitik practitioner Charles Maurice de Talleyrand reputedly exclaimed: “This is worse than a crime. It’s a mistake”. Fast forward a few centuries and it’s not hard to imagine what Talleyrand would make of Italy’s President Sergio Mattarella. In a move that will likely spur fresh elections and put Euroskeptic parties firmly in the ascendancy,...

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    Gavekal Research

    The Incredible Shrinking Krona

    With the US dollar pushing towards its 2017 high, it may be time to scout out value in the currency markets. One option is the Swedish krona, which is down -7.2% against the dollar this year, making it the worst performing G10 currency. Three weeks ago Charles argued that the krona was so cheap that Swedish assets offered a “heads I win, tails I don’t lose” type of trade. I don’t disagree, yet in the intervening period, the krona has...

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    Gavekal Research

    What Bothers Me About The Eurozone

    With Italy facing a constitutional crisis and likely fresh elections within months, attention is set to again focus on Europe’s single currency system. One effect of the euro is that it distorts self-correcting price adjustments, which regulate normal market-based economies. Understanding this dynamic is crucial, argues Charles, if equity investors are not to be pulled into value-traps, of the type which are now presenting themselves.

    1
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    Gavekal Dragonomics

    Property Tightening Is Back

    Chinese government policy for the property market is turning tighter, a shift that will weigh on housing sales and construction activity in the rest of 2018. But Rosealea cautions against overreacting, arguing that the downcycle in property is still likely to be a shallow one, and that policy will loosen again once market conditions weaken.

    2
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    Gavekal Research

    Europe’s Italian And Turkish Troubles

    On the face of it, the collapse on Sunday evening of attempts in Italy to form a coalition government comprising the populist and Euroskeptic Five Star and Lega parties should be good news for European assets and the euro, at least in the short term. On Friday, fears of a populist government in Rome, coupled with the prospect of a no confidence motion and general election in Spain undermined both the euro and peripheral debt. Also down were...

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    Gavekal Dragonomics

    Behind The Resilient Renminbi

    The US dollar is rising, so are US interest rates, and China’s current account balance is deteriorating. So the renminbi should be weakening, but it is not. In this piece, Chen Long argues that a recent pickup in capital flows is the cause of this strength, but suspects the central bank will not want to see much more sustained appreciation.

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    Gavekal Research

    Does The Dollar's Run-Up Have Legs?

    Being a US dollar bear has been a humbling experience over the last few weeks. The year started well enough for bears, with the DXY dollar index declining -4.2% over the first seven weeks. But since mid-April, the US currency has staged a rebound vigorous enough to leave the DXY up 1.95% year-to-date. This rally confronts investors with a baleful prospect: any further sustained appreciation of the US dollar will have a detrimental effect on...

    4
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    Gavekal Research

    My Kind Of Safe Haven

    Long and sometimes bitter experience of financial markets has taught me that when the organically-produced fertilizer hits the rotary ventilation device, a few assets go up in price, while the vast majority go down. The first list is a short one, but on it you will always find the Swiss franc. Historically, the problem with this Swiss-franc-as-safe-haven idea was that the gnomes’ currency usually tends to be something of a collector’s item....

    3
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    Gavekal Dragonomics

    Urbanization Without Migration

    The story of China’s urbanization has long been the migration of people from the country to the cities. Not anymore: as Ernan explains, rural migration has slowed sharply, and is being replaced by the reclassification of rural areas into urban ones. Policymakers now prefer this “local urbanization,” even though it delivers less income growth.

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    Gavekal Research

    A Structural Change, Or A Return To The Mean?

    Chinese government bond prices have markedly outperformed treasuries for more than a year. This trend could be explained merely by cyclical factors, or that the Chinese fixed income market is going through a structural rerating, driven in part by the internationalization of the renminbi and the inclusion of Chinese government bonds in major benchmarks.

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    Gavekal Research

    A Decision Tree For Emerging Markets

    Over the last five weeks, something unusual has been going on in global financial markets: the US dollar has been strengthening, and at the same time the price of oil has been going up. If prolonged, such a simultaneous rise in two of the world’s most important prices will threaten to inflict a vicious double blow on emerging market economies and asset prices. To be clear: the bigger influence would be the US dollar. But the simultaneous...

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    Gavekal Research

    India Macro Update: Summer Market Blues

    Indian growth is picking up nicely just as the external financing environment gets tougher, with a strengthening US dollar, raising yields and most importantly, a sharply rising oil price. In their regular quarterly review, Udith and Tom argue that India can weather the storm, but global investors would do well to back away from the market.

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    Gavekal Research

    Giuseppe Who?

    The leaders of Italy’s Five Star and Lega political parties on Monday nominated little-known law professor Giuseppe Conte to be the country’s next prime minister. Assuming president Sergio Matarella accepts their choice, Conte will be tasked with leading a coalition government whose disparate members have little in common except populism, euroskepticism, and expansionary fiscal plans.

    2
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    Gavekal Research

    The Resurgence Of Political Risk

    Political risk is now the main driving force of financial markets. In 2017 investors learned—or thought they had learned—that political upheavals just create noise, with no lasting effect on market trends that are set by economic fundamentals. But in 2018 this relationship has been reversed. Wherever we look today—at oil prices, global trade flows or conditions in Europe—politics seems to overwhelm economic fundamentals and set the market trends.

    2
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    Gavekal Research

    A UK Consumer Reckoning

    This week saw the release of moderately good news for the Brexit-bound UK economy, as wages rose the most in almost three years. With inflation moderating, real incomes have edged higher, giving hope that consumption can again fire up growth. The problem is that the UK—like the US—increasingly displays late cycle characteristics, as shown by a tight labor market and falling profit growth.

    0
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    Gavekal Research

    Oil As A Party Spoiler

    I have tended to see oil not so much as an asset in which to build a position as a party spoiler that can wreak havoc on a portfolio. Yesterday saw the price of Brent break above US$80 a barrel for the first time since November 2014 and the pain is visible in a range of emerging markets that run big external deficits. To be sure, most of my colleagues remain sanguine about EM prospects and do not expect a generalized crisis (see The Refuge In...

    2
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    Gavekal Dragonomics

    An Attractive But Troublesome Market

    From June 1, China’s domestically-listed A-shares will be included in the MSCI Emerging Markets index, bringing the onshore market to the attention of many global investors for the first time. In this piece, Thomas examines recent developments in the A-share market, and outlines the promises and pitfalls of investing under China’s “regulatory firestorm”.

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    Gavekal Research

    Video: The Hong Kong Peg Under Pressure

    The Hong Kong Monetary Authority has again been intervening in the foreign exchange market after it stepped in last month when the Hong Kong dollar fell to its weakest in 35 years. So far the HKMA has bought HKD62bn, selling almost US$8bn to defend the Hong Kong dollar’s peg to the US dollar. In this video interview, Tom Holland explains what’s going on, and why there is zero risk Hong Kong will be forced to devalue its currency.

    0
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    Gavekal Research

    Beyond Japan’s 1Q GDP Contraction

    Japan’s longest run of growth since the 1980s has come to an end. After eight consecutive quarters of growth, data released on Wednesday morning showed that the Japanese economy contracted in the first quarter. For investors, the question is whether this contraction will prove a short-lived blip, or whether it marks a decisive turn for the worse in both Japan’s macro-environment and equity market.

    2
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    Gavekal Research

    The Next Phase Of Eurozone Reform

    During last year’s French presidential election, Emmanuel Macron opened a debate by asking “what do we want to do with the euro?” His answer was more political integration and burden sharing. Those plans must get traction at the June 28-29 meeting of European Union leaders if they are not to be crowded out by a likely messy end to the Brexit process and next year’s European Parliament elections. Right now, this seems a long shot and attention...

    0
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    Gavekal Dragonomics

    Bond Yields Have Further To Fall

    After a sharp decline in March and April, Chinese onshore bond yields have bounced back over the past three weeks. But based on the latest economic data and policy signals, Chen Long thinks that bond yields have further to fall. Growth is continuing to slow, and the central bank seems comfortable with a slightly more accommodative stance.

    0
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    Gavekal Research

    Playing A Flatter US Yield Curve

    The US yield curve could invert towards the end of this year or early in 2019, the head of the St. Louis Federal Reserve said on Monday. For investors it’s a troubling thought. Over the last 50 years, whenever the US yield curve has inverted, a recession has typically followed within a year or two. Yet although the current flattening of the curve is set to continue, the process will be gradual, which means inversion and an ensuing recession...

    0
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    Gavekal Research

    The Refuge In Emerging Markets

    The year started in such promising form for emerging markets. Unfortunately, the initial promise failed to outlive January. Since early February’s mini-panic, emerging market assets have taken a beating, hammered by the triple whammy of a stronger US dollar, higher US yields, and rising oil prices—a combination that’s typically adverse for global growth, and so deeply negative for emerging markets. The strain has shown up first among “weak links...

    0
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    Gavekal Research

    The Outcomes In Italy

    Political uncertainty isn’t always bad news. It is now 10 weeks since Italian voters went to the polls in a general election, and still Italy’s bickering political parties have not managed to form a stable coalition government. That hasn’t proved an obstacle for investors. Since the election, Italian equities have gained 9.7% in euro terms, 6.4% in US dollar terms, making Italy the world’s best performing major stock market over the year to date.

    0
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    Gavekal Research

    Malaysia’s 92-Year-Old Populist

    It is surely the most remarkable political comeback of recent history. At the tender age of 92, former prime minister of Malaysia Mahathir Mohamad won a shock victory in Wednesday’s general election, ousting from power the coalition he himself headed for 22 of the 61 uninterrupted years it ruled the country—ever since independence in 1957.

    0
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    Gavekal Research

    Hardly A Game Changer For Oil

    While nobody could have been surprised by the full-scale commercial warfare launched against Iran by President Trump yesterday, his announcement raised more questions than answers. The most important question is whether this action will make the world safer or further destabilize Middle Eastern and global geopolitics. The second question is whether the US enforcement of sanctions will really be as tough as Trump’s belligerent rhetoric and the...

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  • Gavekal Dragonomics

    What’s Really At Stake In The US-China Rivalry

    It is still possible that the US and China will strike a deal to avert threatened tariffs. But as Arthur argues in this piece, any deal will be mostly cosmetic. The tension between the two is not mainly about trade, but about China’s challenge to US global dominance. The US will almost certainly keep trying to counter China’s efforts to gain power.

    1
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    Gavekal Research

    What—Me Worry?

    What should most worry investors about the state of the US economy today? The answer is: “Total absence of worry”. That was my clear conclusion after a week in Los Angeles hobnobbing with the thousands of CEOs, financiers, technologists and politicians at the Milken Global Conference. An intoxicating cocktail of tax cuts, deregulation and record profits has transformed the post-crisis normalization of business confidence into uncritical euphoria.

    0
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    Gavekal Research

    The Illusion Of Liquidity, And Its Consequences

    A decade ago the US corporate bond market was about half as big as it is today, yet bond dealers held about six times more inventory than they do today. In our latest Loser Report which focuses on assets to avoid, Louis worries that the next big financial accident could happen in this aggressively priced arena.

    8
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    Gavekal Research

    Time To Stop Thinking

    In a long career spent trying to formulate reliable investment rules, here is one I have found to work time and again without fail. If two assets show no historical trend, and if in the past their relative price has always reverted towards its historical mean, then when that relative price reaches two standard deviations away from its mean, it is time to stop thinking and just play the mean reversion. Now is one of those times.

    3
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    Gavekal Research

    EMs And The Oil Syndrome

    Having fallen more than -10% from their late January peak, emerging markets are looking shaky. Higher yields, a stronger US dollar and rising oil prices have all contributed to a tough environment. In the face of big current account deficits, Turkey and Argentina look properly imperiled, with some saying that their troubles point to a bigger problem for emerging economies. I disagree. Not all headwinds are created equal, and what matters for EMs...

    0
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    Gavekal Research

    Next On The US-China Telenovela: Investment Curbs

    An unusually large group of senior American officials has landed in Beijing for two days of talks on the trade and technology dispute embroiling the US and China. There is no reason to think the mission will achieve much. And if it does manage to cobble together a temporary deal to forestall the tariffs the two countries have threatened against one another, it will do nothing to delay the next act in the drama: proposed restrictions on Chinese...

    0
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    Gavekal Dragonomics

    Seizing The Moment For Artificial Intelligence

    As the US and China try to position themselves for technological leadership, both are now focusing on artificial intelligence. In this piece, Andrew answers the questions of the moment: What is artificial intelligence anyway? Why does China seem to be doing so well in artificial intelligence? And how should we think about this US-China rivalry?

    1
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    Gavekal Research

    Fade The US Dollar Rally

    If a week is a long time in politics, then three months is an eternity in the foreign exchange market. Three months ago, sentiment towards the US dollar reached a nadir after US Treasury secretary Steven Mnuchin expressed his desire for “a weaker US dollar”. Over the following weeks, the US currency duly weakened. But since mid-April the dollar has staged a rally, with the DXY index gaining 3.5% as the market has noted the increase in US long...

    1
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    Gavekal Research

    Strategy Monthly: Living With US-China Strategic Rivalry

    A gaggle of US cabinet officials are in Beijing this week for talks aimed at lowering the temperature on US-China trade relations. While there may be an agreement to temporarily delay the huge tariffs each side has threatened to impose on the other, there is no chance of bridging the real rift between the two countries, which arises from China's technological and geopolitical ambitions. A trio of aggressive strategies launched by Xi Jinping...

    0
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    Gavekal Dragonomics

    Punishing People, Not Institutions

    The strategy behind China’s financial overhaul is becoming clear. It is helping banks by allowing an extended transition to a new set of rules. But prosecutions of executives are also ramping up. This is the opposite of what some Western countries did after the 2008 crisis: people, not institutions, are paying the price for financial risk-taking.

    0
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    Gavekal Research

    Why A Curve Inversion Matters

    Investors are increasingly obsessed about the flattening of the US yield curve, leading to talk of the dreaded “I” word. This is not surprising as inversions have usually been followed by a US recession and attendant equity bear market.

    5
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    Gavekal Research

    The American Growth Dynamic

    It is clear from data released on Friday that the US economy remains set on an expansionary and inflationary trajectory. Growth in 1Q18 came in at a stronger-than-expected 2.3%, while the US employment cost index rose 2.8% YoY to a high for this cycle. Even as consumer spending comes off the boil, US firms, in what looks like a classic late-cycle pattern, are responding to bottlenecks by investing more in their capital stock. We continue to see...

    0
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    Gavekal Research

    Europe’s Coiled Spring Currency

    There was a neat circularity to yesterday’s press briefing by Mario Draghi. The European Central Bank was happy to stick with its monetary accommodation as growth data had softened and the euro was pleasingly weaker. Hence, as German exporters go through one of their periodic bouts of angst and confidence readings pull back across the eurozone, the logic runs that the euro could now slide further. This would especially seem to be the case as...

    3
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    Gavekal Research

    Portfolio Construction In The Time Of An Inflationary Reserve Currency

    In today’s Daily, Charles argued that the key focus of economic conflict between the US and China may end up being over currencies rather than trade spats. He advised investors to monitor the price of treasuries as expressed in gold to see how that struggle is playing out. In this piece, he tells unconstrained investors how to hedge a portfolio in light of the US dollar being subject to inflationary policymaking. Spoiler alert: the answer also...

    3
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    Gavekal Research

    The Upcoming Monetary War, With Gold As An Arbiter

    When President Trump was recently asked if he was starting a war in traded goods with China, he countered that the US had lost that struggle 20 years ago. As the US retains a comparative advantage in technology, such arguments have led some to conclude that the world’s two biggest economies will fight their next economic battle in this new theater. That may be true, but for me the real fight will be less about trade than a struggle for dominance...

    0
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    Gavekal Dragonomics

    Constructive Make-Believe On The Korean Peninsula

    With North Korea suddenly seeming happy to negotiate with its old adversaries, some analysts reckon the regime is buckling under US pressure. Yanmei says this is wishful thinking. Kim Jong-un probably believes he has achieved nuclear deterrence—and he is most unlikely to relinquish it. China and South Korea just want to avoid a US military strike.

    2
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    Gavekal Research

    Why India’s Growth Is Not Jobless

    India desperately needs to create jobs if it is not to squander what may be the biggest “demographic dividend” in economic history. On the face of things, it looks to be blowing that opportunity, as in recent years the size of the workforce has actually shrunk. In this piece, Tom argues that the raw data obscures a picture that while not ideal, is far better than it looks.

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