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    Gavekal Research

    Another Take On The Payrolls

    The last two days have seen my colleagues offer erudite commentary on the meaning of the US non-farm payroll report for May (see Thinking Dark Thoughts and The Dissonance In Jobs). I would simply observe that things take time to properly coalesce and the message from the US labor market is consistent with recessionary signals dating back to the 1960s.

    0
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    Gavekal Research

    On Populism

    The ruling class, which over the last 20 years has done so much to manage our decline, has found a new enemy in the shape of political “populism.” While acknowledging that times have been tough, what so annoys this elite is the realization that “we the people” do not recognize that a complicated world is being run in our own best interests. For this reason it is no great surprise that such ingrates have been labelled populists.

    7
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    Gavekal Research

    Here Comes US Deflation

    Regular readers will be aware that I expect the next big move in prices to be down rather than up and that this shift will occur against the backdrop of a weakening US economy, possibly one that is contracting. Consider the chart below and my contention is that we may be close to that point.

    0
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    Gavekal Research

    Portfolio Construction For Fence-Sitters

    Just over six months ago, I published a Daily note in which I quoted the late American sage Yogi Berra: “When you come to a fork in the road, take it!” My thesis was simple. At the time, the world had reached the point when—in a normal cycle—investors would tend to sell the US market, preferring instead to buy into non-US markets (see The Gavekal Ethos).

    0
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    Gavekal Research

    Heading Passively To The Poorhouse

    It is astonishing the number of articles one can read all claiming to “show” that passive investments consistently outperform active money managers. Their conclusion is always the same: savers should invest in indexes or tracker funds rather than actively-managed funds, and that as a result they will be much better off. This claim has been repeated so often it has become received wisdom. Alas, in this case, as in so many others, the received...

    3
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    Gavekal Research

    Trump And The Tree People

    Recently I reada bookcalled Je n’ai plus peur (I am not afraid any more)by the French writer Jean-Claude Guillebaud. I do not know Guillebaud personally, but even though he is very much on the left of the French political spectrum, I must confess that I have read all his books, and that I have always liked what he has to say.

    7
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    Gavekal Research

    Vertigo And The US Economy

    Regular readers will be familiar with my contention that persistently low interest rates lead not to economic growth and sunlit uplands, but instead to a structural decline in the growth rate and stagnation. Based on this analysis, I have for a while expected a US economic contraction. That one has not yet materialized means there is, however, an obligation to check whether I have been barking up the wrong tree.

    3
  • Gavekal Research

    Updating The US Recession Indicator

    In January last year I penned a piece whose simple thesis was clear from the title (see Towards An OECD Recession In 2015). The idea was that each time the rentier owner of capital made more money than the entrepreneur (on a worldwide basis) in the previous 12 months, a recession in the OECD materialized some time in the next 12 months. Returns for the rentier were computed using the 12-month total return of 10-year treasuries and those for...

    1
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    Gavekal Research

    Marginal Analysis In Capital Markets

    At the end of the 19th century, a revolution hit economics with the arrival of what is called “marginal analysis”. The idea was simple: prices were not determined by average demand meeting average supply, but by the marginal demand meeting the marginal supply; and the resulting price was used to determine the value of all the products or assets concerned. As long as nobody interfered with this price, it guaranteed a proper allocation of scarce...

    5
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    Gavekal Research

    The Fed’s Price Keeping Operation

    The US equity market is a constant source of surprise, but what really amazes Charles is any suggestion that it is “trying to tell us something”. Between algorithms, indexation, regulations, exchange traded funds, structured products, trackers, negative interest rates and of course massive central bank intervention, “Mr. Market” probably has little to say, save that he is hopelessly lost.

    1
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    Gavekal Research

    We Are Killing The Wrong Pig

    Lord Keynes, who was a lot smarter than most Keynesians, argued strongly in favor of the euthanasia of the rentier. I see the logic. The rentier has almost by definition a huge preference for liquidity (to use the Keynesian terminology), which leads automatically to a very low velocity of money, and from there to recession. So the idea is to force the rentier into a lower preference for liquidity, which should lead to a higher velocity of money....

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  • Gavekal Research

    The Bloodhound And The Swedish Economist

    After more than 10 years of researching the theories of 19th century radical bourgeois economist Knut Wicksell, Charles concludes that Keynesian monetary policy, which holds market interests down relative to the “natural rate”, leads to slower growth, a more volatile economy, less reliable price signals, and falling P/E ratios. Unfortunately, that is exactly what the US is facing today.

    7
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    Gavekal Research

    A Diagnostic Tool For Bear Markets

    One of the most vexing moments in a money manager’s career comes when one of the team—usually the young intern—asks the question: “So, are we in a bear market or not?” Immediately, everybody on the investment committee jumps into the discussion, and without fail everyone has a strong opinion on the matter. A vigorous debate ensues, and when everything is said and done, a lot more has been said than done—and neither the intern nor anyone else on...

    7
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    Gavekal Research

    Dissolving The People

    Populist movements are being greeted with horror by political elites across the Western world. For Charles this is not surprising for such movements threaten the self-perpetuating and self-interested economic structures which our elites have constructed.

    9
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    Gavekal Research

    Video: On Wicksellian Theory

    0
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    Gavekal Research

    Seeing The Chinese Forest, Not The Trees

    I do not know as much as I should about China, but I would beg readers’ indulgence as I have some general knowledge of how economies work, and some particular insights into economic history. My fairly unoriginal starting point is that the first phase of China’s development, starting in about 1990, required a focus on building infrastructure and this caused particular rules to be adopted. Since the essential roads, bridges, power plants and...

    7
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    Gavekal Research

    Housing And Deflation

    As regular readers will know, I have been warning for some months that the US economy is on the verge of a deflationary bust, which is by far the most dangerous part of any economic cycle (see Four Quadrants: The Growth Question or The Typology Of A Deflationary Bust). So the question readers are probably asking now is this: did the January data released last Friday, which showed US consumer price index inflation accelerating to 1.4% with core...

    3
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    Gavekal Research

    Elijah And The Prophets Of Baal

    As central banks in Europe and Japan push interest rates more deeply negative in an attempt to reflate their struggling economies, it is astonishing that no central bankers seem to have considered that far from staving off deflation as intended, their low rate policies have achieved the exact opposite, bringing the world to the brink of the very deflationary bust they have been trying to avert. For economists steeped in the academic orthodoxies...

    8
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    Gavekal Research

    The Gavekal Monthly: Enter Ursus Magnus?

    January was a hair raising month for investors with a deeply worrying combination of falling oil prices, plunging equities and soaring yields for sub investment grade debt. In this edition of the Gavekal Monthly we seek some answers to the “what next” question, kicking off with Charles and Anatole who take very different views on whether a bear market is upon us.

    0
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    Gavekal Research

    Anatomy Of The Bear

    I wish I shared Anatole’s degree of conviction. In yesterday’s Daily he set out his belief that the current sell-off in financial markets is not the start of “a structural ‘bear market’, still less a structural Ursus Magnus likely to last for many years” (see Is Wall Street In A ‘Bear Market’). I am not so sure. I suspect that what we are witnessing may indeed be the emergence of an Ursus Magnus, the sort of bear market so deep and prolonged...

    2
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    Gavekal Research

    Here Comes Daddy Bear

    For the last few months I have been concerned that a bear market was likely to unfold. It is my considered opinion that we are now on such a trajectory. Of course the next question has to be what kind of bear market, for history suggests that such episodes come in two distinct extremes.

    2
  • Gavekal Research

    Four Quadrants: The Growth Question

    Charles has been on a near 40 year quest to find a rules-based solution to the most basic of economic questions “what is the current situation?”. He has long used his Four Quadrants methodology which categorizes an economy as being in either an inflationary boom or bust, or alternatively a disinflationary boom or bust. In the first part of this series he proposed a framework to show whether the US was in the inflationary or disinflationary part...

    0
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    Gavekal Research

    It’s About The Dollar, Not The Renminbi

    In my 50 year career working in financial markets, I have never seen the money supply of one country move across the border to another country. Hence I must confess to being perplexed when reading recent commentary fretting about “capital flight” from China. Never mind that China’s highest denomination bill is RMB100, meaning that a fleet of trucks would be needed to move any meaningful sums into Hong Kong, but the country still has foreign...

    1
  • Gavekal Research

    Four Quadrants: A Wicksellian Analysis

    In 1978, when still young and creative, I produced my first four quadrants chart. The idea was that there are four basic investment environments depending if economic activity is expanding or contracting, and whether prices are rising or falling. It was usually obvious which state we had just left—for example the UK having suffered an inflationary bust in 1977—but far harder to judge what state we had entered. Being able to make such a call in...

    1
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    Gavekal Research

    The Gavekal Monthly: The Balance Of Risks

    The new year has been a wild ride so far, with sharp drops in the renminbi, Chinese stock markets, and oil prices leading global markets down. In our first Gavekal Monthly of 2016 we try to make sense of the risks facing investors today. As usual there are some strong differences of opinion: Anatole argues that developed economies are in decent shape, the dollar's rise will soon be over, and equities should post a better performance than...

    0
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    Gavekal Research

    The Last Holdout Of US Value

    Some readers have expressed surprise at my contention that the US stock market is “not that expensive” as their direct experience suggests otherwise. The objection is reasonable, so I have conducted a review of my US equity valuation model. I like to compare equities to a long-dated US zero coupon bond because it has the same annual volatility as the US stock market. Hence, the chart below compares the S&P 500 with the price index of a zero...

    0
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    Gavekal Research

    The Apex Of Market Stupidity

    In some 40 years of watching financial markets, my dominant emotion has been a mixture of curiosity, amusement and despair. It seems the stock market must have been invented to make the maximum number of people miserable for the greatest possible amount of time. The bond market, meanwhile, has just one goal in life: to make economists’ forecasts for interest rates look even more silly than their other predictions.

    8
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    Gavekal Research

    Why Not To Trust In Central Bankers

    More than ever investors are fixated with central bankers, whether it be the latest utterance of Janet Yellen or what Mario Draghi may announce later today. To my mind, there are bigger issues on the horizon.

    6
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    Gavekal Research

    When To Reduce The Volatility Of An Equity Portfolio

    Having worked as a money manager with mandates that allowed me the freedom to move at will between cash, bonds and equities, while still being measured against the world equity index, my key asset allocation decision was always when to reduce the portfolio’s volatility below that of the benchmark—and which tool to use in pursuit of this goal.

    0
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    Gavekal Research

    Lament For A Vanished Middle East

    It is desperately saddening to see the terrified population of the Middle East fleeing for refuge towards a Europe that has utterly forgotten what the region looked like just a few decades ago. Yet nobody can hope to understand the disaster that is unfolding if he knows nothing of the events that shaped the modern Middle East.

    7
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    Gavekal Research

    Poverty Still Matters For Capitalists

    Since 2000 the median US household income has fallen by -7% in real terms as living standards have declined for the poorest members of American society. As Charles explains in this follow-up to his July 2014 paper, Poverty Matters For Capitalists, this worsening impoverishment has been inflicted largely by monetary policy mistakes, and threatens to drag the entire US economy into recession.

    7
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    Gavekal Research

    A Britisher At Heart

    On Monday, Anatole argued that a British exit from the European Union would rank as a foreign policy disaster of historic proportions (see Brexit: A Blunder To Rank With The Boston Tea Party). This is not the first time I have disagreed with my partner on UK matters, and it will likely not be the last. In recent years Anatole worried about the impact of public spending cuts being pushed through by the Conservative-led coalition government; I...

    4
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    Gavekal Research

    Wicksell And Capital Misallocation

    Accepted opinion among investors is that, when it eventually comes, the Federal Reserve’s first interest rate increase in almost nine and a half years will have been signaled so well in advance and will be so small—effectively from zero to 25bps—that it will have little or no effect on either the financial markets or the real economy. Unfortunately, given the monetary policy settings that have prevailed since 2010, I am not convinced the...

    12
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    Gavekal Research

    The Catastrophe Of Negative Rates

    Yesterday both Reserve Bank of India governor Raghuram Rajan and Bundesbank president Jens Weidmann broke ranks, daring to suggest that ultra-low interest rates may not be such a good thing after all. If rates were held too low for too long, warned Rajan, the risk of financial instability would be greatly heightened, a concern Weidmann shares. Unfortunately, that’s not the half of it.

    13
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    Gavekal Research

    The Gavekal Ethos

    In recent days a number of our readers have expressed surprise—even bewilderment—at the difference of opinions within Gavekal on some important topics. “What,” they ask, “is the Gavekal house view?” This is a perfectly legitimate question, and as chairman of the firm, it is my duty to explain our position.

    3
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    Gavekal Research

    Middle-East Machinations

    Russia and Turkey are increasingly at loggerheads as Moscow escalates its military engagement in Syria. Earlier this month Turkey’s President Recep Tayyip Erdogan threatened to find another gas supplier after Russian jets breached its air space, and in recent days Ankara initiated legal action against Gazprom over the price it is charged for piped gas.

    2
  • Gavekal Research

    The Myth Of Secular Stagnation

    When the European Central Bank meets today, discussion will center on whether it should expand quantitative easing in an attempt to stave off deflation and support the eurozone’s painfully slow growth. In Japan too, talk is about whether the Bank of Japan needs to step up its stimulus efforts. And in the US, the Federal Reserve last month decided to delay calling an end to its own zero interest rate policy amid evidence that US growth is in...

    1
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    Gavekal Research

    The Dollar, Deflation And US Equities

    Is the threat of US deflation really receding? Far from it—for a large segment of the US stock market deflationary pressure is set to intensify, rather than abate, over the coming months. Sure, data for September released yesterday showed an uptick in core inflation (ex-energy and food) to 1.9% from 1.8%, raising expectations that that overall US consumer prices are poised for a moderate uptrend driven largely by housing and healthcare costs....

    1
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    Gavekal Research

    The Financing Gap, Creative Accounting And US Recessions

    The pithy aphorism that there are “lies, damned lies and statistics” is attributed to Benjamin Disraeli. Having spent the better part of my adult life torturing data to prove points, I would certainly agree. But in my view, the British Prime Minister missed a beat, for surely the most predictable form of officially sanctioned lying is the type overseen by accountants.

    0
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    Gavekal Research

    Positioning For A US Recession

    Since the end of last year I have been worried about an “unexpected” slow-down, or even recession, in the world’s developed economies. In order to monitor the situation on a daily basis, I built a new indicator of US economic activity which contains 17 components ranging from lumber prices and high-yield bond spreads to the inventory-to-sales ratio.

    0
  • Gavekal Research

    Philosophical Dominance, Profits And Stocks

    Let us start with a simple idea, which also happens to be validated by the data: stock market returns and corporate profits over the long term have the same growth rate.

    1
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    Gavekal Research

    I Know, I Know...

    ...the US economy is doing fine and after the longest run up in history, may be on the verge of achieving take-off velocity. So why am I so worried? The problem is that my US recession indicator has entered negative territory, after literally collapsing in the last 6 months. Today I will try and explain my concerns about the US, when all others seem fixated by China. It should be acknowledged that since about 2002 the US economy has been managed...

    3
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    Gavekal Research

    Termaillage And The Renminbi

    For years I have felt like a lone voice in the wilderness, monitoring central bank reserves as an important determining factor of what I loosely call “international liquidity”. Suddenly I’ve got company. In the last few weeks everyone has been focusing on the topic, and “experts” by the dozen have penned reports about it. Naturally, I’ve read everything that has passed across my screen, and—sad to say—I’m appalled by the results: an egregious...

    0
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    Gavekal Research

    What To Do With US Bonds

    Given the recent turmoil in financial markets and an intensifying focus on the Federal Reserve’s forthcoming policy decision, it seems a good time to update readers on our thinking about the proper positioning of a US fixed income portfolio. As a starting point, it is worth restating the two main determining factors that influence the yields on longer-dated treasuries.

    0
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    Gavekal Research

    The Four Horsemen Of The Apocalypse

    Markets are entering bear market territory and what vexes Charles and Louis is whether the root cause is a liquidity crunch, a solvency crisis or a deflationary bust. In this wide ranging chart book they explore the problem through the revelatory prophecy of four riders whose presence marked the coming of judgement day. We don’t mean to pile on the misery in what is shaping up as a tough week and the moderately good news is that the-end-of-times...

    0
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    Gavekal Research

    The World Monetary Base And The Dollar

    If the supply of US dollars is declining then, all else being equal, the value of the dollar should rise, and vice versa. This truism can be checked by comparing the annual growth rate of the “world monetary base” with changes in the JP Morgan trade weighted dollar. Regular readers will recall that the WMB is simply the sum of the US monetary base and foreign exchange reserves deposited at the Federal Reserve for the account of foreign central...

    12
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    Gavekal Research

    Surviving The Bear Market

    Never mind whether investors in US equities should buy the dip. The question now is whether a six year bull market is yielding to a bear market. Bears are stealthy animals that tend to creep up unannounced. I have had the nagging suspicion for a while that we were approaching grizzly territory and have been recommending an increasingly conservative portfolio positioning (see Protect And Survive). However, the core of my investment philosophy...

    13
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    Gavekal Research

    How To Build A Reserve Currency

    A store of value, a unit of account and a medium of exchange—these are the three essential characteristics of any proper currency. Needless to say a reserve currency must possess all three. But they are far from enough. A reserve currency must have at least six other attributes too, as Jacques Rueff and Robert Triffin did so much to establish.

    1
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    Gavekal Research

    Cutting The Tail Of The Dog

    When docking the tail of a dog there are (in theory at least) two ways by which the offending appendage can be removed: it can be amputated with a single incision, or instead sliced incrementally so that the poor creature barely notices its loss. The same logic applies to economic policymakers when a “tough” decision has to be made. The Thatchers of this world go for a single chop, while the likes of Hollande or Chirac will always plump for...

    3
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    Gavekal Research

    Who Killed US Productivity Growth?

    Four and a half years ago, in February 2011, I published one of my first pieces of Wicksellian research, entitled The High Cost Of Free Money. In it I wrote that negative real interest rates were going to cause a sustained decline in the productivity growth of US labor, which in turn would lead to a deterioration in the structural growth rate of the economy. In making these observations, I was merely following the logic of 19th century Swedish...

    7
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    Gavekal Research

    Three Ugly Charts

    I would never claim to be an accomplished technical analyst, but I do know how to use a ruler when looking at charts of prices in the markets.

    5
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    Gavekal Research

    5C Overview: Why The Surprise At Slowing Trade?

    I am afraid I am rapidly turning into Gavekal’s resident bear—asleep half the time, grumpy the rest. In particular, I am amazed how some people have suddenly discovered that world trade is going nowhere, and that they are so bamboozled by this strange pattern. Where exactly have they been for the last 15 years?

    0
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    Gavekal Research

    The Signal In Silver (Part II)

    Last year I came up with a chart (shown below) that I found rather intriguing. It showed that on every occasion in the last 100 years when the price of silver dropped more than 25% year-on-year, consumer price inflation in the US took a nose-dive soon afterwards.

    5
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    Gavekal Research

    The Typology Of A Deflationary Bust

    In the summer of 1998 I wrote the first report for a new venture that was eventually to become Gavekal Research. It was called The Typology Of A Deflationary Boom. My contention at the time was that the US was in a deflationary boom and in the report I tried to explain to the tiny handful of readers we then had how to manage money in such a period. Booms and busts tend to be byproducts of the interest rate policies followed by central banks. The...

    18
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    Gavekal Research

    5C Overview: Value, Prices And The Coming Deflation

    Economics started out as an effort to understand why goods and services have a “value” and why this value changes over time. After a few dead ends, such as the labor theory of value, a consensus emerged that the value of any good is the result of individual transactions conducted when both parties gain from the transaction. But the “value” I put on a ring my mother wore may have nothing to do with the price that it might fetch. Price is...

    0
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    Gavekal Research

    The Purpose Of The Stock Market

    When you’ve been around for as long as I have, you can’t help but come to a few conclusions—most of them unhappy. My first conclusion is that the stock market was invented to make as many people as possible as miserable as possible for as much of the time as possible. In this sense the stock market is a roaring success.

    5
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    Gavekal Research

    Go Ugly Early

    I fully recognize that most readers face huge regulatory and commercial constraints in the way they manage their portfolios. Nevertheless I have always believed that, as far as possible, the best starting point for effective portfolio construction is to imagine oneself marooned on a Pacific island, free from the constraints of legacy and the expectations of others.

    0
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    Gavekal Research

    Europe’s Debt-Deflation Dynamic

    Amid all the talk of contagion and demonstration effects emanating from Athens, there is a straight forward question that concerns investors whose domain spreads beyond the lapping shores of the Mediterranean: is the Greek crisis, at its root, inflationary or deflationary? Given talk of new currencies being launched, the obvious fear concerns inflation. I would demur and suggest that a deflationary shock is unfolding. This matters especially for...

    3
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    Gavekal Research

    A Brighter European Dawn

    The political and economic reality is that a 40-year old political neophyte from a “peripheral” European economy has taken the eurocrats to the cleaners. It is clear that the Greek populace knew exactly what was coming and extracted €89bn of “good money” from an exceptionally incompetent European Central Bank. This pool of liquid funds should prove a key support for the next year or two, and with Greece running a primary budget surplus the...

    14
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    Gavekal Research

    Germany Is The Real Risk

    As the Greek crisis apparently reaches its climax it strikes me as odd that the default response is to seek refuge in “safe” German assets. If, as appears quite likely, the flawed euro-system really is heading into the next phase of its denouement, then German assets are the soft underbelly of the system, and they are likely to suffer most. Here is why:

    13
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    Gavekal Research

    5C Overview: Manufacturing And Recessions

    I know that metal bashing and the business of making things comprises a declining part of economic activity in most industrialized economies. Yet as economist Brian Reading used to say in the 1980s, GDP may be getting lighter, but manufacturing continues to have a heavy influence.

    0
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    Gavekal Research

    Gauging The Chances Of A US Recession

    A successful investment strategy requires an early warning system to monitor risks in key markets. Right now, I am most worried about a possible recession in the global system’s most important economy, namely the United States. Any evidence of an impending US recession will surely spark a collapse in investor confidence as it becomes clear that central bankers are not, in fact, the omnipotent creatures of their billing. I am especially...

    2
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    Gavekal Research

    5C Overview: Efficiency, Capital And Bond Market Spreads

    In the “good old days” much of the capital deployed in financial markets was devoted to making markets work better. Until the mid-1980s investment banks were often partnerships whose capital was directly owned by the partners. On occasions when a disorderly market emerged that capital was “put to work”, sometimes for just a few minutes—profitability was very high. Such capital was often “owned” by a family such as the Rothschilds, Barings or...

    0
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    Gavekal Research

    Protect And Survive

    Bond yields keep rising, emerging markets are softening and key cyclical stocks have taken a bath. The more I look at the global situation the more I am convinced that both economies and markets are reaching a point of transition. And as that old sage Yogi Berra said: “When you come to a fork in the road, take it!”

    3
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    Gavekal Research

    Towards A US Recession?

    Yesterday the Federal Reserve minutes showed policymakers to be nervous about the outlook for US growth, and so more likely to extend the zero interest rate policy. I would, of course, argue that this is to confuse cause and effect, as US economic weakness in fact stems directly from ZIRP (see The Untimely Demise Of US Productivity). But what concerns me today is less whether a quarter point rise in policy rates happens next month or in...

    10
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    Gavekal Research

    The Untimely Demise Of US Productivity

    Let’s start with a statement of fact: since 2002 the growth of US productivity, measured as non-farm output per hour worked, has collapsed. Outside of recession periods, this is the first time since the 1950s that the four-year moving average of the annual rate of change in productivity has fallen so low. This matters because without a rise in productivity, the US economy will struggle to boost its citizens’ standard of living, whether measured...

    3
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    Gavekal Research

    Bull Market, What Bull Market?

    Underweighting US equities has become a consensual position and yet the market continues to flirt with new highs. So what gives? My approach has always been to rely on decision rules built on historical data analysis. When enough of these rules signal a “buy” or “sell”, I make a move (for a good example of this approach see Managing Equities In A Strong Dollar World). My esteemed colleague Anatole has been arguing for a while that the S&P500...

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    When Bond Markets Become Silly

    Investors are understandably spooked by recent bond market ructions given a backdrop of weakening growth in major economies, and continued accommodative central bank policy. Francois argued yesterday that this “tantrum” was partly technical, but also the result of markets looking through to higher inflation expectations due to an apparently better economic outlook (see Tantrum II And European Portfolios). I agree with him that markets are being...

    2
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    The Liberties Of England, And What They Mean For Europe

    When the Conservative-led government of the last parliament started to show that it was serious about deficit-reduction and lessening the role of the state in the British economy, I turned very bullish on UK financial assets (see A Supply-Sider’s View Of The UK for a detailed exposition of this view). Perhaps unsurprisingly over the last five years the UK mid-cap index has outperformed the German and French equivalents. I admit to having had a...

    7
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    5C Overview: The Real Message From Labor

    So how are we to understand the less than thrilling message emanating from the labor markets of the main economies. Is this evidence of some unescapable “secular stagnation”, or is something else going on?

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    A Post-Volatility World

    These are words that I utter with the utmost caution—this time, it really is different. I refer not to central bankers’ scurrilous efforts at monetary debasement, nor the spineless diplomacy of European political leaders, or even the cult of celebrity in the age of social media. In some guise, we have seen all of this before. No, dear reader, for something genuinely new to the modern experience, consider the right hand side of the chart below...

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    5C Overview: Why The Coming Collapse Of World Trade Should Be Celebrated

    Sustained economic growth has always gone hand-in-hand with a big rise in communications infrastructure. To explain why, assume that a country has two cities, named A and B. At the point that a modern communication infrastructure is built (road, trains, internet) then, in each case, a single line of communication is needed. Three cities implies the need for three lines; a fourth city means six lines. Ultimately, if all the cities are to...

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    Small Is Beautiful

    At the end of the 1980s the world changed, with the collapse of the Soviet Union and the start of China’s renaissance. The next two and a half decades were marked by a mass movement towards globalization. We now have a long enough history to determine who were the winners over those 25 years. The answer is very simple: small countries.

    1
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    Of Central Bankers, Monkeys And John Law

    A revealing experiment involved monkeys being placed in a cage with a pile of nuts stashed on an upper level. Their efforts to snaffle the food caused them to be doused in water, blasted with a siren and startled by an electric shock. After a number of attempts the monkeys gave up. Later, a second group of monkeys were introduced—the new entrants made a beeline for the goodies, but were quickly beaten back by the chastened first group of monkeys...

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    How Indexation Killed Growth

    Indexing, as I have written before, is a form of socialism, since capital is allocated not as it should be—according to its marginal return—but rather according to swings in the market capitalization of the underlying assets. It is hard to think of a more stupid way to allocate this scarce resource.

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    Three Brothers In Arms: Wicksell, Schumpeter And Fisher

    I am often asked which of the great economists best understood the link between the economy and financial markets. Passing judgment on such giants may be presumptuous, but practical men and women of finance may want to consider being slaves to the following propagators of ideas:

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    Trying To Measure The US Dollar Short Position

    It seems to be conventional wisdom that the long-dollar trade has become worryingly “crowded”. That was certainly the message after last week’s none too startling language tweak by the Federal Reserve produced a frantic dash out of the unit. But as ever, there is what you see, and what you don’t. In this case, what is obscured may be of far greater significance than what is visible in plain sight. Here is why:

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    London Seminar March 2015 - Anatole, François, Andrew & Charles

    We held our main spring seminar in London on March 17 with Anatole, François, Andrew and Charles offering their views of the global economic pulse and recent market and central bank developments.

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    5C Overview: Going Long The Yen

    If I held a decision making role within the Japanese policy apparatus, I would do everything in my power to spur a yen appreciation. Here is why:

    1
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    The Hidden Tax On Savings

    Frederic Bastiat, the great 19th century French liberal thinker, observed that mediocre economists spend plenty of time talking up the immediate beneficial impact of their measures, but usually ignore the less obvious long term effects. He summarized this view with the pithy observation: “In economics, there is what you see and there is what you don’t.”

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    The Financing Gap And Bond Spreads

    So far this month, the yield on the 30-year US Treasury bond has risen from 2.22% to almost 2.73%—a sharp move for such a short period of time. In December, we took a searching look at long rates in the US, and expressed the view that as 30-year Treasury yields dipped below 2.5%—the lower limit of our valuation model for long bonds—it would be time to shorten the duration of bond portfolios from 30 years to seven years (see Managing Bonds In A...

    6
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    Toward System Failure

    As I see it, our obligation to clients at Gavekal Dragonomics is not to make forecasts (they never work) but to explain events and identify likely winners and losers. Such an approach implies that we live in a world where policymakers have a semblance of rationality. My concern is that the negative interest rates policies currently being embraced in Europe fly in the face of this requirement. The implication is that foundational principles of...

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    A Modest Proposal To Save The World

    The last few years have been some of the most intellectually interesting of my career as the post financial crisis period has seen policymakers test the limits of economic theory, and push well beyond. Inspired by their example, I would like to post my small contribution to the sum of new knowledge that this era of extremes has thrown up.

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    5C Overview: Profits and Productivity

    Former West German leader Helmut Schmidt used to say: “The corporate profits of today are the investments of tomorrow and the jobs of the day after.” Put another way, higher labor productivity leads to increased profits, more jobs and a better standard of living. In this regard the chart below shows the link between US profits and productivity growth (centered on its historical mean of 2%). From 1968 to 1993, productivity variations preceded...

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    Panic or Process?

    In the past few months, we have seen surprise interest rate cuts from India, Australia, Russia, Turkey, China, Switzerland, Denmark... the list goes on. So what lies behind all these surprise cuts? Panic, or process? The arguments for panic are obvious, and include:

    5
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    Sweden: The Planets Are Aligning

    Asset allocation is—or at least should be—a process. Investors try to identify the favorable and unfavorable factors driving an asset’s performance, and monitor developments to identify where they stand in the investment cycle.

    2
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    QE: Competitive Devaluation, Or Stealth Bank Recapitalization?

    The battle for morale is half the war. So it is likely to prove in the eurozone, where the impact of quantitative easing will hinge on how investors perceive the European Central Bank’s policy. If they regard it primarily as a competitive devaluation, which would be deeply deflationary for the world economy, then it will make good sense to remain long eurozone bonds and short the euro. On the other hand, if markets decide QE amounts to a...

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    Beware The Correction Of False Prices

    I want to start this paper by reiterating a few of my strongly held convictions about the role of central bankers:

    14
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    Towards An OECD Recession In 2015

    One of the OECD’s jobs is to determine when a recession has hit the overall grouping of developed nations. The chart below shows OECD recessions shaded grey, while US recessions, as decided by the National Bureau of Economic Research, are in pink. The OECD seems to record a recession during periods when the industrial production index for the grouping falls over a 12 month period (one exception was 1995 when a mysterious recession apparently...

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    Swexit!

    So Switzerland’s central bankers have decided that pegging their currency to the European lira administered by ‘Derivative Draghi’—as one of our friends in Hong Kong calls the European Central Bank president—was not such a great idea after all.

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    Setting Aside Emotion And Seeking Reason

    Une nation est une âme, un principe spirituel. Deux choses qui, à vrai dire, n’en font qu’une, constituent cette âme, ce principe spirituel. L’une est dans le passé, l’autre dans le présent. L’une est la possession en commun d’un riche legs de souvenirs ; l’autre est le consentement actuel, le désir de vivre ensemble, la volonté de continuer à faire valoir l’héritage qu’on a reçu indivis. Ernest Renan, Conférence à la Sorbonne, March 1883

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    Managing Equities In A Strong Dollar World

    In December, we examined the rules a fixed income manager should follow when the US dollar is going through a period of structural appreciation. We emphasized that these are different from the guidelines he or she should follow when the US dollar is structurally falling. Equity managers too should change their approach when the US dollar is in a structural up-trend, but the sets of rules they should follow are vastly more complicated than...

    3
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    Stick With US Treasuries

    US treasuries have maintained their stellar performance in the first three trading sessions of 2015 with yields of both the 10-year and 30-year declining more than 20bp. A year ago I advised strongly for investors to buy long-dated treasuries. But last month I suggested a tilt toward shorter duration portfolios due to the changed macro environment and more challenging valuations (see Managing Bonds In A Strong Dollar World). In light of recent...

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    Janet Yellen’s Inner Wicksellian

    As readers may be aware I have written very little on central banks and their policies recently. At the beginning of the zero interest rate policy experiment—which so far has lasted longer than World War II—I tried to explain why I thought it was a terrible idea (see The High Cost Of Free Money). However, I rapidly came to realize that my role was not to tell central banks what they ought and ought not to do, but rather to try to help our...

    2
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    Managing Bonds In A Strong Dollar World

    During my money management career I have come to realize that there are two basic investing environments. There are periods when the US dollar is structurally declining and there are times when it is structurally appreciating. Depending on which condition applies, then anyone running a global investment portfolio should use different decision rules. We are probably moving into a period of structural dollar appreciation, so it seems an opportune...

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    Our Holiday Reading List

    For the third year we are publishing a year-end books round-up. The topics covered by the 17 books in our compendium include hardy Gavekal perennials such as economics, politics and the effect of technological transformation on modern life. In addition Charles considers ancient Rome’s decline due to its apparent embrace of socialism over liberalism. Louis kicks us off with a look at the roots of our most basic human urges.

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    New York Seminar December 2014 - Charles, Francois, Tom & Will

    We held our winter seminar in New York on December 5 with Charles, Francois, Tom and Will offering their views of the global economic pulse and recent market developments.

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    Asset Allocation In The Era Of Cheap Oil

    I’ve read plenty of bullish statements recently saying that the decline in oil prices amounts to a massive tax cut; “a phenomenon that’s making everybody better off,” as US Federal Reserve vice chairman Stanley Fischer declared last week. But as Frédéric Bastiat wrote, in economics you have what you see and what you don’t see, or as Milton Friedman put it: “There is no such thing as a free lunch.”

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    5C Overview: ZIRP And Capital Spending

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    The Signal In Silver

    Since mid-July the price of silver has slumped by -25%. These days silver is mostly an industrial metal. But down the decades it has retained some of its monetary characteristics. What’s more, for more than a century silver has traded freely in the market, unlike gold which only started to float in the 1970s. So the question I am trying to answer is very simple: Is there a relationship between variations in the price of silver and...

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