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    Gavekal Research

    The Eurozone's Sustainable Recovery

    Eurozone retail sales registered their first month-on-month fall in five months in February, prompting fears that Europe’s consumer-driven revival may be faltering. Since last May the price of oil has fallen -32% in euro terms, lifting real wages by 2% and boosting consumer purchasing power across the eurozone. Over the last three months, however, oil has rebounded 22% from its January low, eroding some of the European consumer’s purchasing...

    0
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    Five Corners (8 April): The Outlook For Bank Earnings

    Overview: With banks’ earnings squeezed on one side by flat yield curves, and on the other by tech companies encroaching on their traditional consumer-facing business lines, Louis wonders where the banking sector will generate future earnings growth United States: Doing More With A Flatter Yield Curve: Now consumers have deleveraged, and with strengthening demand set to drive a pick-up in corporate investment, Will argues that earnings growth...

    0
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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:

    11
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    One Belt, One Road, One Grand Strategy

    In what can only be described as a triumph for Chinese financial diplomacy, some 48 countries had defied US disapproval to sign up for Beijing’s new Asian Infrastructure Investment Bank by yesterday’s deadline. The applicants included not only Europe’s big four economies, but staunch US allies such as Saudi Arabia, geopolitical rivals like India, and even Taiwan, which China does not recognize as a separate country.

    2
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    The Darkest Hour Before Euro Dawn

    Two weeks ago we suggested that the euro’s decline against the US dollar—probably the clearest consensus trade of 2015—could soon be over. As luck would have it, we published this article on the very day the euro rebounded from a 12-year low against the US dollar of US$1.05 (see Beware The Euro Consensus). Dumb luck of this kind is certainly not evidence of wisdom or special insight. But now that the modest bounce following the euro’s March 13...

    5
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    5C Europe: Primed For Earnings Growth At Last

    As the great Edward A. Murphy of the eponymous law would have predicted, almost everything that could go wrong for eurozone banks has gone wrong. Not only were they rocked to their foundations by a financial crisis that left most of them on the verge of bankruptcy, but in the aftermath they found themselves violently attacked by politicians of all stripes, and forced to endure huge tax hikes, swingeing fines—including from the US authorities—...

    0
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    Exogenous vs Endogenous Shocks

    Markets can be hit either by endogenous shocks (they collapse suddenly because of the build-up of internal excesses—think the 2000 tech bubble, the 2008 US mortgage crisis, or the 2011-12 eurozone crisis) or by exogenous shocks (9/11 in the US, or the price of oil shooting up from US$100/bbl to US$150/bbl in 2008 following the Sichuan earthquake and preceding the Beijing Olympics). This raises the question how investors should view...

    4
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    The Road To Eurozone Rebalancing

    At a record 7.8% of gross domestic product, Germany is running the largest current account surplus in the world. To put that into perspective, in absolute terms Germany’s surplus over the last 12 months amounts to €218bn. In contrast, China’s current account surplus last year was a relatively modest €161bn. With the European Central Bank’s printing presses operating at full steam and depressing the euro’s exchange rate, Germany’s current account...

    3
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    The Divergence In Market Action

    After yesterday’s trading action, the S&P 500 is now broadly flat for the year so far, and stands at the same level as on November 21. Interestingly, over the past 26 days since February 17, the US index has not managed to string together two consecutive days of gains. In other words, US equities are now adding more volatility and less returns to portfolios. That’s hardly the combination that most investors are looking for. In contrast, the...

    3
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    Five Corners (25 March): Where To Find Value

    Overview: Louis deconstructs the cycle across different regions to work out what investment strategies should work best, and where. North America: David Hay argues that the Canadian dollar may be nearing its trough, and if so, that Canadian REITs offer compelling value. Europe: Turkish assets have suffered recently. But with cheaper oil and a recovery in European demand emerging, Cedric makes the case for an impending rebound. China: With yields...

    0
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    The Panicked Reach For Yield

    Traveling around Europe in recent weeks, we have been struck by how challenging most investors are finding the unprecedented situation created by the launch of the European Central Bank’s quantitative easing program in the context of negative bond yields in the core eurozone countries. These difficulties stem mainly from the contradiction between investors’ urgent need to reach for yield and the reluctance of local regulators and risk managers...

    0
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    Gavekal Research

    5C Europe: Fringe Benefits

    After a stellar performance in 2014, Turkish assets have recorded sizable losses since the middle of January. With a current account deficit running at 5.2% of GDP financed largely by volatile short term capital flows, Turkey has suffered along with other vulnerable emerging markets from a stronger US dollar and rising expectations that the US Federal Reserve will hike interest rates in June. The sell-off has been exacerbated by disappointing...

    0
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    5C Overview: Three Regions, Three Strategies

    Fundamentally, there are three ways to make money in financial markets: Momentum trades: ideally buying high and selling higher. Return to the mean trades: ideally buying low and selling higher. Carry trades: borrowing short to lend long.

    0
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    Gavekal Research

    All 21st Century Roads Lead To...

    With trillions of US dollars’ worth of transactions every day, the G7 foreign exchange markets are supposed to be the most liquid, least prone to manipulation, markets out there. Even so, the five day rate of change of the EUR-US$ exchange rate has lately fluctuated in the +5% to -3% range usually only seen at times of deep market crisis. As a result, most investors, or companies looking at their budgets and sales projections for the second...

    0
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    Gavekal Research

    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:

    7
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    Gavekal Research

    Much Ado About Sterling

    The budget delivered this week by George Osborne will not be enough to win the UK’s May 7 general election for the Chancellor of the Exchequer’s Conservative Party. Instead all signs point to a hung parliament, with no one party holding enough seats to command a majority. Heightened political uncertainty in the run-up to the poll—and quite possibly in its immediate aftermath, given the horse-trading needed to form what is likely to prove an...

    0
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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.

    0
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    Gavekal Research

    Asia Is Not So Scary

    One reason we have received push-back on our call to overweight Asian equities has been the risks associated with a major US dollar spike. Asia has not racked up foreign currency debt at the rate seen in recent years since just before the region’s financial crisis in 1997. Still, we would argue that there are sufficient differences this time around to think that Asia can generate strong performance on lower volatility over the coming year.

    1
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    Gavekal Research

    Who Gains When The Fed Hikes?

    The Fed has lost patience in words only, not in deeds. In its statement yesterday the Federal Open Market Committee dropped its linguistic backstop—the word “patient”—indicating that the first rate rise since 2006 could come as early as June (remember, Fed chair Janet Yellen defined “patience” as meaning there would be no rate hike for at least two meetings after the word’s use). But the underlying message the market took away yesterday is that...

    0
  • Gavekal Research

    Beware The Euro Consensus

    The US dollar is hitting new 12-year highs almost daily and the euro seems to be plunging inexorably to below parity. Recent events in the foreign exchange markets seem to have a fairly obvious explanation which most economists and policymakers accept and endorse. President Hollande, for one, has embraced the plunging euro: “It makes things nice and clear: one euro equals a dollar,” he told an audience of industrialists last week. But it is...

    1
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    Gavekal Research

    The Euro’s Collapse And Consequences

    For years, euro-sceptics have argued that either the euro would have to be a structurally weak currency, or the likes of Italy, Portugal and even France would be unable to survive inside the financial strait-jacket. Clearly, the markets have now embraced this conclusion: notwithstanding yesterday’s counter-trend move, the euro has dropped -5.2% against the dollar this month with a YTD decline of -12.3%. Over the past 12 months the euro has shed...

    9
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    Catching The Krona

    A few months back Sweden looked to be sliding into a crippling deflation. This fear has receded with February inflation data swinging positive for the first time in seven months, following a higher-than-expected reading in January. As a result, yields on 10-year government bonds have risen from a record low 0.48% to 0.68%. Most important for the Swedish currency, the interbank rate has swung positive even though the central bank last month...

    2
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    Five Corners (11 March): Currency Wars

    Overview: Charles Gave wonders whether Japan might surprise by affecting an appreciation of the yen. United States: With the US dollar rampant, Will Denyer runs the numbers against the euro and yen and finds decisively in favor of the yen. Europe: Francois Chauchat argues that as a major trading currency, the euro was never going to be driven just by trade flows. However in the final analysis the strong external position of euroland will make...

    0
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    5C United States: A Crowded Trade, With Good Reason

    The dollar has had quite a run—with the DXY up 22% since July. This crowded trade is obviously vulnerable to pullbacks. But volatility aside, is there potential for the dollar to rally further in the medium term? The short answer is yes, especially against the euro. But if you want to be contrarian, we suggest going long yen. These calls are based on three factors: (i) relative monetary policy trajectories, (ii) the likely direction of fund...

    0
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    Gavekal Research

    5C Europe: The Paradox Of The Euro

    It is an interesting paradox that the sharp decline of the euro since last summer occurred in the context of a “euroglut”—that is the eurozone’s current account surplus which reached €235bn in 2014. Over the last two years many analysts have argued that the euro could not fall meaningfully due to this huge savings surplus. An obvious comparison has been drawn with Japan’s experience in the 1990s and 2000s.

    1
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    Gavekal Research

    In The ECB We Trust (Well, For Now)

    Ever since the European Central Bank announced its €60bn-a-month QE program in January the market has craved answers to some elementary questions. Specifically:

    1
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    Gavekal Research

    Growth & Markets Monthly (March 2015)

    Our latest monthly report shows that the modest recovery in growth indicators, which started last month, has continued. Since central banks are engaged in aggressive easing action on a number of fronts, it would be surprising if this improvement does not continue. In addition, our velocity indicator has rallied and hovers at a six month high, which mirrors the low level of the VIX index. Such readings point to a “risk-on” environment, but we...

    0
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    Gavekal Research

    Germany Normalizes

    Germany gets a bad rap for obsessively chasing export competitiveness to the detriment of its embattled eurozone partners. The relentless pursuit of current account surpluses—now at a record 7.5% of GDP—has caused domestic demand to lag and denied neighbors a source of demand, the opposite of what was intended with the eurozone construction. But this looks to be changing as German real wages grow at the fastest pace in more than 20 years. As...

    2
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    Gavekal Research

    Not The Usual QE

    Now that the Greek drama is temporarily resolved, markets will start to focus on the European Central Bank’s quantitative easing program, scheduled to kick off next month. In the lead up to the ECB’s ‘shock and awe’ announcement most economists became weary on the likely economic efficacy of the program. We would agree that QE is not the ideal tool to quickly revive growth in the eurozone; economic activity would have gotten a stronger boost...

    5
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    Five Corners (25 February): Global Property Wrap

    Overview: Property gets a bad rap from macro-economists as an “unproductive” asset. This mistakes its true value in modern economies, argues Anatole Kaletsky. United States: Despite recent soft housing data, the US housing market is ready to rip, say Will Denyer and Tan Kai Xian. Europe: Francois Chauchat argues that Europe’s housing market may have entered a gently rising cycle for the first time since 2007. China: Property sales have picked...

    1
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    Nice Economy, Shame About The Politics

    While sterling is setting new post-2007 highs almost daily against the euro and on its trade-weighted index, economic optimism seems to outweigh political nervousness as Britain heads towards its most unpredictable election in living memory on May 7. But is Britain’s economic outlook really good enough to compensate for the political mess that almost everyone now expects?

    0
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    Gavekal Research

    5C Overview: The Importance Of Property

    Property, both residential and commercial, is the world’s oldest investment and, in the long run, the most reliable and profitable store of economic value. Like the world’s oldest profession, however, it operates in the financial shadows. Property lacks the transparency of mainstream asset classes such as equities, bonds and currencies, with no completely objective price benchmarks to measure returns reliably even in sophisticated markets such...

    3
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    Gavekal Research

    5C Europe: The Green Shoots Of Recovery

    Until recently, the post-2008 trajectory of property prices in the eurozone could be summarized as (i) recovery in Germany, (ii) bust in previously hot markets such as Ireland, Spain, the Netherlands and Italy, and (iii) stability in most other countries, notably France and Belgium.

    0
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    A Cosmetic Victory For The Reformers

    On the face of things, it looks as if last week brought two major victories for Europe’s structural reformers. On Friday Greece’s finance minister Yanis Varoufakis was forced to blink first and accept an extension of his country’s existing bailout package under austere terms dictated largely by the German Finance Ministry. Just two days earlier the French government resorted to presidential decree to force a package of structural reforms...

    0
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    Gavekal Research

    Patience Is A Virtue

    The clichéd phrase “patience is a virtue” does not, strictly speaking, refer to the sort of patience promised by the Federal Reserve in its minutes last night. When Janet Yellen speaks of “patience”, she means a wait of at least three month before she does anything—however gentle—that could conceivably impede US economic growth. But the patience described by medieval Christian scholars as one of the “Seven Heavenly Virtues” was not the opposite...

    1
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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...

    7
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    The Risks Recede in Europe

    What is the opposite of a perfect storm? Whatever the term for a sudden confluence of three unexpected blessings—or for the simultaneous removal of three mortal perils—European markets are about to enjoy it.

    2
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    Gavekal Research

    Assessing 'Thatcherite-Keynesianism'

    Talk of ‘Grexit’ again grips the eurozone. At stake is the legitimacy of a model of top-down economic management which uses bailout funds in a carrot-and-stick exercise to force through structural reform. The end game for Northern policymakers is to force the adoption of new practices and structures in the name of improved competitiveness. With the toughest fiscal constraints having been eased over the last year, this seems a good time to...

    0
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    Gavekal Research

    Five Corners (11 February): The Earnings Squeeze

    Overview: Charles contrasts US companies' strong accounting profits with the less impressive numbers reported in the national accounts and asks some hard questions. United States: The latest earnings season revealed a tale of two markets with multinationals and energy firms lagging while domestics surge ahead. Will and KX ask whether this can last. Europe: François argues that if eurozone GDP growth picks up to the degree that the...

    0
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    Denmark's Dilemma

    Is something rotten in the state of Denmark? Following last month’s shock de-pegging of the Swiss franc, investors have increasingly targeted the Danish krone, challenging Copenhagen’s three-decade-old fixed exchange rate policy. This has set up a battle between the market on one side and the Danish central bank on the other.

    0
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    Gavekal Research

    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.

    6
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    5C Europe: What A Few Decimals Of GDP Growth Could Change

    In contrast with the IMF, the European Commission recently revised upwards its forecast for GDP growth in the euro zone for the next couple of years, on the back of lower oil prices and a lower euro. The EC now expects +1.3% real growth in 2015, versus +1.2% for the IMF, and +1.9% in 2016, versus +1.4% for the IMF. These numbers imply that the sequential growth rate would rise towards almost 2% by the end of this year according to the EC, while...

    0
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    Greeks Gaming Themselves Out

    Yanis Varoufakis, the new Greek finance minister, is a professor of economics who specializes in game theory, but when it comes to negotiating strategy he has more to learn than to teach. Varoufakis’ idea of a winning strategy is to hold a gun to his own head and then demand a ransom for not pulling the trigger. Not surprisingly, this bluff has been called, first by the German government and now by the European Central Bank. As a result the...

    11
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    Gavekal Research

    Greek Risk Is Not About Debt

    European markets staged a vigorous relief rally yesterday after Greek finance minister Yanis Varoufakis dropped his calls for a write-off of Greece’s public debt, proposing instead a package that would include the exchange of European Financial Stability Facility loans for growth-linked bonds. Yet contrary to what the Greek and German governments pretend and to what we read in the press, Greece’s public debt is not the real issue either for...

    0
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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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    Turning Cautious on US Equities

    Given their remarkable performance over the last four years, can US equities really continue to outperform global peers? Recent developments give cause for concern as market technicals look weak and earnings announcements for bellwether stocks have come in lackluster. Earlier this week Louis asked some basic questions about US equity market leadership (see Does It Still Make Sense To Overweight US Equities?). We share his concern not because we...

    4
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    Asia’s Encouraging Currency Stability

    Three months ago to the day, the US Federal Reserve ended its outright purchases of treasuries. Three months before that, the ECB instituted negative interest rates. And whether by coincidence or causation, most commodity prices chose the past six months to unravel. The combination of these events has led to some sharp exchange rate moves. Over the past three months, commodity currencies have been taken to the woodshed: the Russian ruble is down...

    0
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    Gavekal Research

    Does It Still Make Sense To Overweight US Equities?

    Investment decisions are typically driven by the costs of five factors: land, labor, capital, energy and government. One of the key theses of Too Different for Comfort, the book I wrote a couple of years ago (available for free download here), was that in the years following the Asian Crisis of the late 1990s, Asia boasted one massive comparative advantage: a much cheaper cost of labor than anyone else. So for ten years, any new factory,...

    2
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    Five Corners (28 January): In Central Banks We Trust

    Overview: When central banks led a war on inflation in the late 1970s and 80s they kept on fighting long after the enemy was beaten into submission. They are likely to take the same approach of using overwhelming force in today’s fight against deflation, says Anatole. United States: The Swiss may have given forward guidance a bad name, but the Fed should be taken at its word, argues Will Denyer. Unlike Anatole, he thinks that interest rate...

    3
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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...

    9
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    The Greek Endgame

    With most votes counted it looks as if the euro system has helped give birth to the continent’s very own Hugo Chavez, with the third largest party in Greece’s parliament being neo-Nazis. Nice work! With Spain going to the polls later this year and Italy never far from its next political imbroglio, Greece offers a glimpse of what Europe’s political future could look like. The question is whether the irresistible rise of Alexis Tsipras and his...

    1
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    5C Europe: How Milton Friedman Helped Save The Euro

    Since the euro’s inception economists have considered the attempt to conduct central banking in a fiscally decentralized currency zone as challenging at best, and at worst doomed to fail. Hence, Milton Friedman said the eurozone would not survive its first recession.

    0
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    5C Asia: Will The BoJ Follow Suit?

    Governor Haruhiko Kuroda’s comments at the World Economic Forum in Davos last week set off speculation that the Bank of Japan may soon expand its program of quantitative easing. Our base case is that the BoJ is unlikely to oblige QE enthusiasts in the next 6-12 months as Japan is currently in a ‘honeymoon’ period where lower inflation is likely tolerable.

    0
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    Towards Eurozone Reflation (Part II)

    The European Central Bank has finally crossed its Rubicon. Yesterday ECB president Mario Draghi unveiled plans to buy at least €1.1trn of public, private and supranational debt securities over the next 20 months. And if necessary, the ECB could extend and accelerate this quantitative easing program, expanding its balance sheet by as much as €3trn, or 30% of the eurozone’s gross domestic product, to hit its inflation target.

    1
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    Positioning Prior To The ECB Decision

    With the European Central Bank set to make its big announcement on quantitative easing tomorrow, the market is already pricing in a game changer. This makes portfolio positioning today a difficult task. Lofty expectations have increased the odds of disappointment, and yet investors can be excused for not wanting to position themselves for a fight with the ECB—after all, it could actually decide to fire up its printing presses in earnest. We have...

    3
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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...

    5
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    Who Will Profit From Eurozone QE?

    Finally, the European Central Bank is expected to launch its first program of full-blown quantitative easing, buying sovereign bonds outright with freshly-printed euros. The announcement could come as soon as this Thursday’s policy meeting. But there are big questions still unanswered over how exactly to conduct QE in a currency union made up of supposedly independent countries and autonomous governments.

    0
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    Gavekal Research

    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.

    10
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    The SNB Loses Its Nerve

    Central banks have been at pains to use “forward guidance” as a tool to demonstrate transparency and with it make their policies credible. So investors got quite a shock yesterday when the Swiss National Bank abandoned a near 40 month commitment to peg the EUR/CHF exchange rate at 1.20. In its place the SNB escalated a policy of negative interest rates in an effort to deter hot money inflows; the 3-month Libor target was cut by -50bp to -0.75...

    7
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    Gavekal Research

    QE And The Drift To Euro-Stagnation

    It’s official, or at least very nearly. Sovereign debt purchases in the secondary market by the European Central Bank are legal under European law. This was the opinion of the European Court of Justice yesterday when giving a preliminary ruling on the ECB’s program of Open Monetary Transactions which was proposed in 2012 although never actually used. The ruling removes a key obstacle to the ECB adopting quantitative easing although the court...

    0
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    5C Europe: A J-Curve For Corporate Profits

    There are three main ways that the oil price counter-shock should deliver higher real economic growth in the eurozone economy (see The Triple Merit Of Lower Energy Prices).

    0
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    Gavekal Research

    Europe’s Quantitative Teasing

    On Wednesday the eurozone is likely to inch a step closer to quantitative easing when the European Court of Justice hands down its preliminary ruling on the legality of the European Central Bank’s program of Outright Monetary Transactions proposed in 2012. While the ECJ is expected to find that the OMT lies within the ECB’s competence (to use Euro-jargon), any qualifications it makes will go a long way to determine the shape of a eurozone QE...

    0
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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

    7
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    Gavekal Research

    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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    From Greed To Fear

    For the last two and a half years since June 2012, the best strategy for global equity investors has been to buy on dips. The strategy worked because of a very high level of market resilience combined with a (sometimes excessively) optimistic environment. As a result, over the last couple of years markets have tended to recover very quickly from shallow corrections.

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    The Long Shadow Of The Commodity Bust

    The commodity boom of the past decade had all the hallmarks of a typical bubble: massive retail participation (through ETFs, mutual funds etc…), large pension fund involvement, a widespread belief that ‘this time, things were different’ and that a ‘commodity super-cycle’ was unfolding. But like all bubbles, this one too has come to an end. There were plenty of potential triggers in the shape of (i) the Federal Reserve’s decision to stop printing...

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    Gavekal Research

    Europe's Corporate Jurassic Park

    Corporate Europe has now suffered through two years of an unwonted profit drought. Since early 2013 the eurozone’s gross domestic product has swung from a -1% year-on-year contraction to between 0.75% and 1% growth. The historical relationship between GDP growth and earnings per share implies that EPS growth should have picked up in tandem with the—admittedly modest—pick-up in economic growth. Yet the aggregate level of eurozone EPS is roughly...

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    Catching The Russian Knife

    Why does a country with US$416bn of foreign exchange reserves and a current account surplus bigger than China or Japan relative to the size of its economy, suffer a currency crisis? The obvious answer is that the country is called Russia and it has launched an undeclared war against the US and EU. On closer inspection, however, this year’s 50% devaluation of the ruble, which culminated with an apparent death-plunge on Wednesday morning after the...

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    Oil: Lower For Longer

    How low can the oil price go? And how long can it stay down? These two questions are weighing on the mind of every investor in the world these days, to the exclusion of almost everything else. Nobody can respond to the first question with any confidence—although we take a stab below—but the second is actually pretty easy to answer.

    3
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    Gavekal Research

    Europe Not EMs At The Vortex

    In the summer of 1998, Russia’s financial crisis stemmed from the oil price plunge that followed the Asian financial crisis. Today the worry is that Russia’s fall is causing a cycle of contagion which could pull down even decently managed emerging economies. Unusually, this collapse is happening just as the world’s biggest asset allocators prepare to effectively shut up shop. It is rare to get a full blown crisis over year-end simply because...

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    Gavekal Research

    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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    Gavekal Research

    Oil And Contagion

    So much for the gentle year-end that looked to be in store after the swift recovery from October’s sell-off. Investors now face an acute dilemma as oil demand estimates get scaled back and the energy complex howls: does the effective tax cut delivered to oil consumers outweigh the effects of capital destruction and rising bad debt that must result from a 40% fall in prices? US equity investors have mostly cheered the onset of $2 a gallon...

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    Gavekal Research

    Draghi’s Job Just Got A Lot Harder

    The specter of debt default is once again haunting the eurozone. Failure by the Greek government to get its candidate elected president in a December 17 parliamentary vote will lead to a general election in January; an election that the radical left wing opposition party Syriza, which is currently ahead in the opinion polls, stands a real chance of winning. The prospect triggered a sharp sell-off in Greek government bonds yesterday, with the...

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    Gavekal Research

    Five Corners (10 December): Contrarian Ideas For 2015

    Overview: Anatole Kaletsky looks at the struggle between the Middle-East sheiks and US oil producers and concludes that oil is about to finally conform to standard economic theory. One unintended consequence may be the effective liquidation of western oil majors. United States: Will Denyer considers the dramatic scaling back of the US shale oil sector but argues that US capital spending should do just fine next year. Europe: Francois Chauchat...

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    Gavekal Research

    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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    Gavekal Research

    5C Europe: To Resist Or Succumb To Russia’s Value Call?

    With a stagnant economy, collapsing oil prices, painful EU sanctions and a grinding war in Ukraine to finance, the case for investing in Russian equities, to say the least, looks poor. Add to these huge challenges recurring rumors of capital controls, and you have a potent cocktail that is likely to scare away even the most adventurous, and battle scarred investors.

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    Sweden Goes Italian

    Sweden, normally a model of collegiate common sense, is gripped by political chaos. The Social Democrats, once Sweden’s natural party of government, snuck back into power after a general election eight weeks ago allowed them to cobble together a coalition. The government has moved to jack up taxes and unwind the previous administration’s private school reforms and adoption of for-profit healthcare. The rival right wing alliance is grumpy, but...

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    Gavekal Research

    The Burning Questions For 2015

    With two reports a day, and often more, readers sometimes complain that keeping tabs on the thoughts of the various Gavekal analysts can be a challenge. So as the year draws to a close, it may be helpful if we recap the main questions confronting investors and the themes we strongly believe in, region by region.

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    Gavekal Research

    Crunch Time, Really, For The ECB

    There is an odd dissonance to the spin that has led up to tomorrow’s European Central Bank’s meeting. On the one hand, ECB officials are doing their best to paint the move towards full-blown quantitative easing as manifest destiny. Indeed, the economic conditions seem to merit such action given awful PMIs released this week for France, Germany and Italy, which together account for two thirds of eurozone GDP. Yet there is a parallel track of ECB...

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    Gavekal Research

    Growth & Markets Monthly (December 2014)

    This month saw our main growth indicator drop into negative territory for the first time in more than a year. The key drags were the commodity-related components and the underperformance of growth-sensitive stock markets such as South Korea and Sweden. The chief concern for markets is whether lower oil prices and the new monetary activism of the Bank of Japan and promises of action from the European Central bank can help reignite market momentum...

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    Gavekal Research

    Quarterly Strategy Chartbook - Avoiding The Pitfalls Ahead

    Forces of creative destruction are building up in the world economy as never before. Several of Gavekal’s key indicators are signalling that we are moving into a mild deflationary boom, in which cheaper resources, lower technology costs—especially for robotics—and accelerating disintermediation—notably in the financial sector—all promise to act as game-changers over the coming years. Reliably picking winners in such disruptive times is difficult...

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    The Great Policy Convergence

    Yesterday’s announcement that the European Central Bank is preparing to buy government bonds from the first quarter of next year is an event of historic importance. As the logical follow-up to Mario Draghi’s commitment to expand the ECB’s balance sheet by €1trn, yesterday’s statement by ECB vice-president Vitor Constâncio confirms beyond reasonable doubt that Europe is ready, at last, to implement full-blown quantitative easing, over-riding the...

    1
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    Gavekal Research

    Five Corners (26 November): Capital Spending In 2015

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    Italy Inches Towards Reform

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    Global Central Banks Are Driving Appetite For US Cyclicals

    The rebound in US equities since their mid-October trough has been impressive. After giving up almost all its year to date gains in just four weeks, the S&P 500 snapped back even more quickly, ending October at a new record high. Since then, it has extended its advance to notch up a YTD gain of 12%. Yet, until just a few days ago, the relative performance of sectors within the index indicated a degree of caution on the part of investors....

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    Gavekal Research

    5C Europe: Reasons To Believe In A Capex Cycle Trough - François Chauchat

    Brussels will today reveal financing details of a much touted plan to boost capital spending in the European Union by €315bn, or about 2% of GDP. The intention is commendable since the core eurozone part of the community has seen investment as a share of GDP shrink to a historically low 11% (ex-dwellings). But although the program should be helpful, on its own it is unlikely to be a game changer. Simply put, there are three potential sources...

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    Gavekal Research

    Where Next For Eurozone Equities?

    Eurozone equity markets have swung through a classic behavioral finance cycle this year. Optimism in the first quarter turned into complacency in 2Q, concern in 3Q, and capitulation in October (see The Liquidation of Euro-optimism). Since then, starting in the middle of last month, European markets have rebounded nicely, getting their latest fillip from Mario Draghi’s speech last Friday, in which the European Central Bank president pledged that...

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    A Balanced Portfolio Alternative

    In recent weeks Charles has argued forcefully that the specter of deflation looms large. He sees capitalism returning to its “19th century roots” of deflationary booms and busts. He points to the wide dispersion of weak prices and in yesterday’s Daily added a twist by highlighting weak silver prices as a reliable predictor of price declines (see The Signal In Silver). If you accept this view, the next question becomes whether price signals point...

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    Here Comes The Melt-Up

    Back in mid-October as stock markets around the world plunged faster than at any time since 2011, many investors and economists feared a meltdown. But with the US economy steadily expanding, monetary and fiscal policy becoming more stimulative in other parts of the world and the autumn season for financial crises now over, a melt-up seems more likely than a melt-down.

    0
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    A US vs UK Asset Allocation Model

    Over the long term, there is no reason why the UK stock market should offer a higher—or lower—return than the US market in dollar terms if the two countries operate in an open system and are similarly (badly) managed. Equally, there is no reason for the US bond market to outperform or underperform the UK bond market since—in an open system—the risk-free rates must be the same. If one market has outperformed the other for a considerable period...

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    Bank Shares And Deflation Risks

    Over the years, I have learnt the hard way to pay a good deal of attention to the behavior of bank shares. Simply put, when interest rates and bank shares fall in tandem the market is offering a clear signal that very bad news is on the way.

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    Five Corners (12 November): The Commodity Fallout

    Overview: Louis Gave Considers the poor performance of gold mining stocks and wonders if energy companies are set to go the same way.

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    Gavekal Research

    Beware The British Roller Coaster

    Mark Carney’s quarterly press conference at the Bank of England tomorrow could be the catalyst which reminds investors of the warning that we have issued several times over the past few months: Britain is no longer a haven of political and economic stability amid the turbulence in Europe—and this loss of safe-haven status is not yet remotely discounted in British asset prices, especially the sterling-dollar exchange rate and prime property in...

    4
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    Gavekal Research

    Never Let A Good Crisis Go To Waste

    In most countries, new leaders typically benefit from a six month honeymoon before insiders start griping to the Fourth Estate about how dysfunctional their administration really is (usually out of resentment that someone else got a coveted job). That’s not the case in the European Union. Even before he’s measured his windows for curtains, European Commission president Jean-Claude Juncker is having to cancel media events (as he did on Sunday in...

    4
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    5C Europe: Ruble’s Fall Is Both Threat And Shock Absorber

    The ruble’s recent devaluation has exceeded falls seen in previous periods of weakening oil prices as Western sanctions have created a shortage of foreign exchange. At the same time, fears that Russia will impose capital controls has triggered outflows. Russia’s central bank has denied rumors that it is pulling up the drawbridge on its capital account and says it is sticking with a planned move towards an inflation targeting regime that will...

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    Draghi Succeeds In Buying Time

    Mario Draghi did a reasonably good job of wresting back the monetary policy initiative yesterday, after several weeks in which the European Central Bank president had appeared on the back foot and under pressure. Hesitant communications about the ECB’s balance sheet target, and a series of Reuters ‘leaks’ suggesting the central bank’s governing council was irreconcilably divided and therefore largely impotent had threatened severely to undermine...

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    Gavekal Research

    Gridlock Itself Is Not The Problem

    The votes are in and the result is yet more gridlock in Washington. For the US there is nothing unusual in this situation. Presidents have been opposed by both houses of Congress in 32 out of the 70 years since WWII, and opposed by one house in another 14 years (see here). However, political paralysis is becoming the norm in many democracies, especially in Europe. An important question is therefore how different countries and regions can cope...

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    Take Profits On Hungarian Bonds

    Hungary has been Europe’s stand-out economic performer this year, outgrowing both its Central and Eastern European counterparts and its larger Western neighbors. While much of the continent has faltered, Hungary has surprised on the upside, with growth hitting 3.8% YoY in the second quarter; its highest reading since 2006. Meanwhile, unemployment has fallen back to 2007 levels, inflation is at a record low, and the country’s external accounts...

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    Deflation: Boom Or Bust?

    It has been my contention for a while that capitalism is returning to its 19th century deflationary roots. Indeed, the evidence for this assertion has become overwhelming. The consumer price indices of 13 OECD countries have negative YoY readings. Another eight are below 1%. In the case of “goods inflation,” all European economies are flashing negative. And if the likes of Italy or Spain thought that salvation lay with an “internal devaluation...

    2
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    ECB Credibility On The Line

    The latest reading of the German IFO survey may have surprised on the downside, but the balance of recent hard and soft data suggests the eurozone has experienced nothing worse than a summer “soft patch”. A triple-dip recession is unlikely and it is more likely that European growth will re-accelerate on the back of a strengthening US economy, a weaker euro, lower oil prices and improved fiscal and credit supply conditions. All this should...

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