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    Gavekal Research

    The World's Most Crowded Trade

    Markets are made at the margin. As a result, the key driver of prices for a given asset is the question of where the marginal buyer (or seller) comes from. This is why very crowded trades can prove dangerous: by the time every one and their dog is convinced that (i) the euro can only go down (early 2015), (ii) being short long-dated bonds is the single best trade out there (early 2014), (iii) underweighting European equities is the easiest path...

    6
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    Gavekal Dragonomics

    Property Is Still Too Big To Let Go

    While the share of China’s economy driven directly and indirectly by real estate and construction has declined over the past three years, it is still substantial at roughly one-third. This means that the government cannot afford to be relaxed about the housing market as fundamental demand starts a long-term decline.

    0
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    Gavekal Research

    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?

    0
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    Gavekal Research

    5C United States: Forget Payrolls, Watch Out For Wage Growth

    Not so long ago most of what the savvy investor needed to know about the US economic cycle could be gleaned from a casual perusal of the labor market. Sadly for those seeking a simple life, those days have passed. For example, key measures of labor market slack offer mixed messages; the participation rate is stuck below the trough of the last two cycles which points to the working age population being under-utilized. Yet, a greatly reduced...

    0
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    Gavekal Research

    5C Europe: Still Waiting For Pay Day

    Although it started from an extremely low base, the recovery of the eurozone’s job market since 2013 has been significant, with employment rising by almost 1% YoY in 4Q2014—the highest growth rate since 2008. Recent business surveys indicate that this trend has continued and even accelerated into 2015.

    0
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    Gavekal Research

    5C China: Policymakers Are Concerned, With Good Reason

    China’s labor market has held up relatively well so far this year despite a pronounced slowdown in growth. But the actions of policymakers and the trajectory of the economy both suggest that there will be more bad news for the job market in the second half of the year. Official indicators of employment in China are patchy, but the published figures have been resilient.

    0
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    Gavekal Research

    5C Asia: Japan’s Wageless Recovery

    Unlike the countries of the eurozone, which are plagued by persistently high unemployment, Japan is suffering from a labor shortage. Yet despite the dearth of workers, economic recovery has not fed through into wage rises—a cause of much frustration in Tokyo.

    0
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    Gavekal Research

    Beware Of Crowds, And False Prices

    The world’s largest economy is on the cusp of a deflationary depression—at least according to yesterday’s US GDP report. Real growth was up a mere 0.2% annualized in the first quarter, while nominal growth was even lower, at just 0.1%, due to a -0.1% drop in prices. Yet the markets largely looked past this “shocking” report. There were some notable moves yesterday, but not because the market was pricing in economic disaster—far from it.

    6
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    Gavekal Dragonomics

    The End Of The Margin Squeeze

    The profits of Chinese industry have not grown since August, but the worst of this crunch now seems to be over. The fall in industrial profits was all but guaranteed by the combination of an extended slowdown in housing construction and the aftershocks of the collapse in commodity prices in late 2014 (see Profits Under Pressure). But thanks in part to the recent stability in oil prices, China’s industrial sector is on course to avoid a worst-...

    0
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    Gavekal Research

    China: QE Or Not QE?

    Press reports that China’s central bank is preparing to launch quantitative easing may give investors the impression that the People’s Bank of China is about to join the ranks of major central banks that have embraced unconventional monetary policies. This impression would be false. The PBOC is certainly in easing mode, but its methods have been, and will continue to be, entirely conventional. With the benchmark deposit rate still at 2.5%, the...

    4
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    Gavekal Research

    Whither US Manufacturing

    US economic data has started to surprise on the downside, and much of this can be attributed to the manufacturing sector. This is worrying since the sector often leads the general economy. Hence, the $64,000 question is whether we should be bracing for an unscripted recession? Our answer is no, but investors should underweight the US manufacturing sector. In the near term, price adjustments, largely stemming from the energy and commodity price...

    3
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    Gavekal Research

    The Pros And Cons Of A Bull Market

    In sharp contrast to their approach in 2007, Chinese government officials are actively encouraging the current bull market in onshore equities, repeatedly saying that rising share prices are a good thing for China. We agree that there are definite economic advantages to the run-up in stocks, but it is also worth keeping an eye on the risks.

    3
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    Gavekal Research

    Starving The Greeks Out

    After Friday’s near-total breakdown in the negotiations between Greece and the eurozone, it is clear that both sides need a Plan B. In the case of Greece the alternative to a negotiated solution has always been clear. It is to default on its debts to other European governments, thereby presenting those nations with a stark alternative: either expel Greece from the euro and risk contagion to Portugal, Spain and Italy, or offer Greece the money it...

    12
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    Gavekal Research

    The Rebirth Of CEE Banking - Cedric Gemehl & Nick Andrews

    Who will benefit most from Europe’s extraordinary monetary easing? Will it be struggling giants such as Italy and France, or those lapping up liquidity on the fringes? Our contention is that Central and Eastern Europe is at the early stage of a “deflationary boom” while financial institutions have sufficiently recovered to transmit the European Central Bank’s quantitative easing program into credit expansion.

    0
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    Gavekal Research

    No One Likes To Pay Taxes

    No one likes to pay taxes, and a good few try to find a way around it. Perhaps this is why the US tax code and associated practice notes runs to 74,000 pages. Pretty much everyone feels better equipped to spend their own money than the government, and rightly so (anyone who pretends differently is a hypocrite; or did not earn their money themselves). This is why as people pay more tax there is demand for a clear accounting of the services...

    2
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    Gavekal Research

    A Tactical Shift On Greece

    As angry rhetoric between Athens and eurozone finance ministers escalated last week, the drumroll towards Grexit appeared to be reaching a crescendo. But having raided the coffers of state enterprises this week, the Greek government can now pay its bills until June. No less significant was the move by the European Central Bank to prop up Greek banks in the face of deposit flight by upping its Emergency Liquidity Assistance limit by €1.5bn to €...

    3
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    Gavekal Research

    Maritime Silk Road Or “String Of Pearls”?

    China’s strategic expansion into the Indian Ocean is causing jitters in both Washington and Delhi. This week Xi Jinping pledged to finance a whopping US$46bn of investments in Pakistan, a large chunk of which will fund a 3,000km “economic corridor” from the Arabian Sea to northwest China. The route will begin at Gwadar, a Chinese-run port near the Iranian border, which Indian security experts fear will become a strategic base for the Chinese...

    0
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    Gavekal Research

    Five Corners (22 April): Global Trade

    Overview: Charles Gave argues that an era of globalization and expanding world trade is coming to an end. On balance, he says this is no bad thing. United States: The negative impact of the strong dollar on US exporters will become clear once disruption from the early year port strikes on the US West Coast clear up according to Will Denyer and Tan Kai Xian. Europe: Europe’s huge trade surplus is purely a German issue. François-Xavier Chauchat...

    0
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    Gavekal Research

    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...

    3
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    Gavekal Research

    Towards A Real Japanese Shake-Up

    International investors, otherwise disposed to embrace Japan’s re-rating story, face a real dilemma. Almost 30 months after Shinzo Abe launched his bold reflationary experiment, Japan’s equity market has more than doubled in value and the yen (on a trade-weighted basis) has devalued by -30%. And yet, throughout this period, economic growth has continued to disappoint. With two significant reforms in the offing, we reckon that could be about to...

    0
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    Gavekal Dragonomics

    Trembling Giants

    Political and public pressure is building for an overhaul of China’s state-owned oil companies. China National Petroleum Corp. and Sinopec Group, formed in the 1980s from government departments, are among the largest companies in China and their influence is difficult to overstate (two other state energy firms, CNOOC and Sinochem, are smaller and less powerful). Nevertheless the political winds are now blowing against them and a change of some...

    0
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    Gavekal Research

    Drop The Dollar Hedge

    The United States represents more than half of global equity benchmarks (58% of the developed-market world MSCI and 52% of the all-country version). So the key question every global equity investor must answer is whether to be overweight or underweight the US?

    5
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    Gavekal Research

    5C Europe: The Euroglut Is All About Germany

    By depressing imports, the deflationary bust of 2011-2013 in the non-German areas of euro-land clearly contributed to the emergence of the eurozone’s monster €200bn trade surplus. But from a longer term perspective, there is no doubt that the “euroglut” has been and remains an overwhelmingly German story. Ex-Germany, the trade balance of the eurozone has only managed to recover to its pre-boom level of the early 2000s. In contrast, Germany’s...

    0
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    Gavekal Research

    5C China: No Mourning For The Death Of Outsourcing

    What is China doing about the loss of a big driver of export growth? Back in the days when total exports were growing at a 20%-plus annual rate, up to half of that growth came from the outsourcing of manufacturing assembly to China (we use processing trade, a customs arrangement used by many outsourcing factories, as a proxy). But the outsourcing boom of the 1990s and 2000s has faded lately. Since 2012, processing trade has essentially stopped...

    0
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    Gavekal Research

    5C United States: Competitiveness Lost

    We must be in a global recession! At least that is the conclusion an investor might draw if looking only at US trade data. US import and export volumes both collapsed by an annualized –25% in the first two months of the year, something not seen since the 2008 recession, and 2001 before that. An assessment of trade values would result in an even worse conclusion being drawn—a deflationary depression is underway. The truth is that the situation...

    0
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    Gavekal Research

    Fuel To The Fire

    As if the flames under Chinese equities weren’t hot enough already, Beijing is busy throwing fuel on the fire. Yesterday the People's Bank of China said it would cut the reserve requirement ratio for banks by 100bp, with an extra 100bp cut for small rural institutions. This is the greatest reduction in RRRs since November 2008 in the depths of the global financial crisis, and unlike the previous cut in February it is not intended merely to...

    1
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    Gavekal Research

    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...

    0
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    Gavekal Research

    5C Asia: Deflationary Rebalancing

    Take a look at Asia’s trade data, and you soon notice a striking divergence: export volumes and prices are heading in different directions. In the past, whenever external demand picked up, Asia’s exporters always enjoyed a beta-bounce on the back of rising pricing power. This time around, however, things are different. Despite the ongoing recovery in the US and the recent upturn in Europe, Asian exporters have found themselves forced to make...

    0
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    Gavekal Research

    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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    Gavekal Research

    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...

    9
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    Gavekal Research

    The Danger Of Grexit Complacence

    Grexit is growing more likely by the day. Yesterday Wolfgang Schäuble, the German finance minister, said in New York that financial markets had “priced in” all possible outcomes of Greece’s debt woes, arguing there is no risk of contagion to other eurozone members. At the same time, Greek finance minister Yanis Varoufakis is in Washington, where according to reports he is scheduled to meet Lee Buchheit, a senior lawyer who specializes in...

    0
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    Gavekal Research

    The Crocodile Mouth About To Close

    What is the most significant macro event thus far in 2015? Most of our clients would likely answer the collapse in oil prices. Or perhaps the European quantitative easing program and the fall of the euro. Others, more bearishly inclined, may highlight the relentless and tedious process towards Grexit, the underwhelming US macro data or the devastating Middle-Eastern civil war. These are all perfectly valid answers—in fact, we made a number of...

    16
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    Gavekal Research

    Slumping Growth, Booming Market

    The gap between China’s booming stock markets and slumping economic growth just got a lot wider. Figures for the first quarter published today showed a picture of nearly unrelieved gloom, with most growth readings at their weakest since the first quarter of 2009 when China was suffering from the global financial crisis. This poor performance is not surprising, given the structural slowdown in the housing market, falling corporate profits, anemic...

    0
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    Gavekal Research

    Instability Lies Ahead For The UK

    What country faces the highest degree of political risk in Western Europe? And whose financial markets should therefore carry Europe’s biggest political discount? Six months ago, when we first argued that Britain was in danger of losing its safe haven status, both in the political sense and as a tax haven for international capital, this was still a matter of speculation. Now, with the May 7 election only three weeks away, our warnings about the...

    1
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    Gavekal Research

    The Perils Of Leadership

    Around 50 countries have signed up to join China’s Asian Infrastructure Investment Bank. A year ago, when Beijing began to draw up plans for a new multilateral lender, no one could have guessed that it would cause such a global stir. We first wrote about China’s attempt to provide an alternative to the US-dominated system of global development finance last June (see [China] A Chinese Bretton Woods?). But it is too early to conclude that the...

    0
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    Gavekal Research

    The Best Of Both Worlds In Hong Kong

    My mother often said that the main reason she pushed Charles to return to work following the sale of his previous business in the mid-1990s was that having a retired husband was the worst of both worlds: “Less money and more husband”. On this measure, Hong Kong should be happy today. In its troubled marriage with mainland China, it looks very much as if Hong Kong is about to get “more money and less mainlanders” out of its conjugal partner. In...

    1
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    Gavekal Research

    A Turning Point For Eurozone Bank Lending

    Is it too early to celebrate the green shoots of a eurozone recovery? Most recent data has been positive with retail sales expanding at the fastest rate since the early 2000s, PMIs signaling a broadening of growth to the struggling periphery and unemployment in most economies continuing to decline. Green shoots can easily wither in response to shocks or bad policy choices, but there is one good reason to think this recovery may have legs: bank...

    4
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    Gavekal Research

    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.

    7
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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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    Gavekal Dragonomics

    Developers Fatten Up For The Long Winter

    China’s beleaguered property developers are finding their way to a new strategy. While the real-estate boom of the past decade rewarded those who could build the most the fastest, the structural slowdown in housing demand that is now underway (see Housing’s Next Decade) calls for a different approach. Consolidation not expansion is the order of the day: in 2014, developers sharply increased their spending on mergers and acquisitions, even as...

    0
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    Gavekal Research

    Growth & Markets Monthly (April 2015)

    In this post-Easter edition of our Growth & Markets Monthly report, we note a continued (albeit slight) improvement in our growth indicators, which are now hovering in neutral territory. By contrast, our risk measures suggest that the appetite for risk taking is still strong. This provides a decent foundation for continued equity market gains. Growth is decent (but not so strong as to spook central banks), inflation is still missing-in-...

    0
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    Gavekal Research

    Buy On China Skepticism

    Widespread skepticism about the power of monetary policy at the outset of easing cycles can provide great investment opportunities. Despite clear lessons about the effects of central bank activism in the US in 2009, Japan in 2012 and Europe in 2014, international investors still doubt the quality of the bull run in China’s onshore stock markets ignited by the People’s Bank of China. As a result, even though the Shanghai A-share market has...

    0
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    Gavekal Research

    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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    Gavekal Research

    Thai Decision Rule Signals Time To Buy - Joyce Poon & Udith Sikand

    It would take a courageous investor to buy wholeheartedly into Thailand’s equity market just now. The country’s ruling generals may have lifted martial law last week, almost a year after seizing power, but local analysts dismiss the move as a cosmetic attempt to persuade Thailand’s Western allies that things are returning to normal. In reality, they report, the government is actually seeking to tighten its control in the face of undiminished...

    2
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    Gavekal Dragonomics

    The Short Tale Of Iron Ore's Long Fall

    Commodity prices boom when supply is slow to respond to surging demand, and collapse when supply finally catches up. The iron ore market is clearly in the second phase now, with global supply surging just as Chinese demand slows. In this piece we outline the fundamentals for iron ore, which mean that prices will remain lower for longer.

    0
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    Gavekal Research

    The US Market’s Silver Lining

    We are no bulls on the US market. Even if growth remains solid, our view is that US equities will struggle to post yet another year of outperformance given that valuations are already stretched, the Federal Reserve is no longer the easiest central bank in town, and the US dollar is no longer super-competitive (see Does It Still Make Sense to Overweight the US? and Turning Cautious On US Equities). Even worse, decent growth is not a given. While...

    0
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    Gavekal Research

    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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    Gavekal Research

    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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    Gavekal Research

    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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    Gavekal Research

    5C Overview: The Challenge Confronting Banks

    When one ponders the inexorable rise in the market value of Apple, Google, Amazon or Facebook, one is left with a simple question: once a company’s market capitalization is worth hundreds of billions of US dollars, how does it grow? Surely selling smart watches won’t move the needle all that much. Neither will delivering by drone. This simple reality may help to explain recent reports that Apple is moving aggressively into the electric car...

    0
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    Gavekal Research

    5C US: Doing More With A Flatter Yield Curve

    Banks borrow short and lend long. Hence profits are a function of a) the steepness of the yield curve, and b) how much risk (and return) banks are willing and able to reach for at the long end of the curve—taking either duration risk or credit risk, or both. With this in mind, we consider earnings potential in the three key areas:

    0
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    Gavekal Research

    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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    Gavekal Research

    5C China: The Worst Is Yet To Come

    China’s banks are going through their toughest times since the central government bailed them out at the end of the late 1990s banking crisis. After 10 years of double digit growth, the earnings of China’s five largest banks grew by only 6.5% in 2014. Fourth quarter profit growth was actually negative. China’s smaller banks have performed better than their larger counterparts, but even so their profit growth has also slowed significantly. What’...

    0
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    Gavekal Research

    5C Asia: Capturing Beta From India’s Laggard Banks

    The stars could hardly be aligned more propitiously for India’s economy. The falls in oil and other commodity prices have helped to correct the external deficit and have paved the way for the Reserve Bank of India to continue its monetary easing cycle. On the fiscal side, in February Narendra Modi’s government underscored its pledge to prioritize investment when it proposed a 25% YoY increase in capital expenditure in its first full year budget...

    0
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    Gavekal Research

    Where Has The Modi Magic Gone?

    India has fallen out of favor with investors lately. Over the last four weeks, the Nifty stock index has dropped 4.6%, a fall that included eight consecutive sessions of declines, the market’s longest losing streak in more than 18 months. Investors blamed the collapse of lofty valuations following poor earnings results, with the fall exacerbated by rising tensions in the Middle East. But critics of India’s government say the problems go deeper....

    5
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    Gavekal Dragonomics

    The Relevance Of Bank Reserve Cuts

    China is set to make further cuts in the extraordinarily high reserve requirement ratio it imposes on its banks. In early February the People’s Bank of China reduced RRRs for the first time since May 2012, cutting the ratio for all financial institutions by at least 50bps (with a bigger cut for selected banks). However, even after February’s cut, the RRR for big banks remains at 19.5%, a punishingly high level by international standards,...

    0
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    Gavekal Research

    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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    Gavekal Dragonomics

    Macro Update: A Broader And Deeper Slowdown

    2015 is off to a soft start for China. The housing downturn in 2014 led to economic pain that was concentrated in regions and sectors that supplied steel and other construction materials. But now the slowdown is spreading through the rest of the economy, with corporate profits and consumption starting to show weakness. Monetary policy will continue to ease in response, though neither a strong surge in credit growth nor a big depreciation of the...

    0
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    Gavekal Research

    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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    Gavekal Research

    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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    Gavekal Research

    China Update: A Rare Bond Market Bright Spot

    The rule of thumb in all of our fixed income models used to be that the nominal yield on ten-year government bonds for a given country should be equal to the country’s ten-year average inflation rate plus the structural real growth rate of its gross domestic product (i.e. demographic growth + productivity gains). So, for example, if the US were to see 2% GDP growth (1.2% productivity gains and 0.8% demographic growth) and 2% inflation, then the...

    0
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    Gavekal Research

    The Fed’s New Policy: Zero Real Rates

    The Federal Reserve is convinced that the US is not turning Japanese—even though the US consumer price index was flat in February compared with a year ago, having fallen -0.1% in January. Once the effects of lower oil prices abate, the Fed expects inflation to head back toward its 2% target. Whether policymakers are right about this inflation outlook means everything for the trajectory of future policy rate hikes, for two reasons:

    2
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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...

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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...

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    Gavekal Dragonomics

    Managing The Disappointment In Housing

    China’s housing market has gotten off to a very bad start for the year, with housing sales falling 18% YoY in January and February, the worst decline since 2009. The terrible data are another reminder that we have entered a structural downward trend in housing demand, which means that sales are more likely to undershoot than to overshoot. But the negative trend also means that previous government concerns about overheating housing prices and...

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    5C Asia: Japan Finally Gets Religion

    Japan has been tough on value investors. With no catalysts to unleash shareholder value, investors have typically found themselves sitting on their portfolios waiting for the Grim Reaper. Time and again activist funds have tried to release locked-up value, only to be blocked at every turn by intransigent management and unsympathetic regulators. Now the market is watching with considerable interest to see how Daniel Loeb’s Third Point Management...

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    5C China: A Rare Bond Market Bright Spot

    The rule of thumb in all of our fixed income models used to be that the nominal yield on ten-year government bonds for a given country should be equal to the country’s ten-year average inflation rate plus the structural real growth rate of its gross domestic product (i.e. demographic growth + productivity gains). So, for example, if the US were to see 2% GDP growth (1.2% productivity gains and 0.8% demographic growth) and 2% inflation, then the...

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    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...

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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.

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    5C North America: Northern Exposure

    The Canadian dollar is currently trading at CAD1.25 to the US dollar, some 20% weaker than in early 2013 and back at levels last seen in the darkest days of the global financial crisis. Following the collapse in energy prices, some believe the loonie is set to weaken even further, towards the CAD1.60 levels touched in the early 2000’s, when the currency was nicknamed by Americans “the northern peso”, and Canada itself dubbed “the banana...

    0
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    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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    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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    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...

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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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    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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    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...

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    Don’t Bet On A Renminbi Depreciation

    A number of clients have asked recently when we think the renminbi will start to weaken against the US dollar, and how far we expect it to fall. With the euro and the yen having both recorded double digit percentage falls against the US currency over the last six months, and with the Taiwan dollar down -4% and the Korean won now down -7% after the Bank of Korea cut interest rates last week to a record low, the renminbi is a glaring exception....

    1
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    A Petty And Short-Sighted Hissy Fit

    The UK’s decision to join China’s new Asian Infrastructure Investment Bank is turning into a diplomatic triumph for Beijing and a disaster for Washington. France, Germany and Italy say they will follow the UK’s lead. South Korea and Australia, which the US urged not to sign up when the bank was established last October, are reconsidering. Even Japan, the most stalwart US ally in Asia, is rumored to be wavering.

    1
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    The US Corporate Profit Paradox

    The US equity market is richly valued and faces a buffeting headwind in the shape of the soaring dollar. Our recommendation in recent months has been to dial back exposure, but committed investors should stay concentrated in domestic plays rather than firms with a big reliance on international earnings (see Turning Cautious On US Equities). Such a portfolio orientation was borne out by generally weak 4Q14 corporate earnings. But a key part of...

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    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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    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...

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    Quarterly Strategy Chartbook - Rapidly Shifting Sands

    With the US economic recovery maturing and China’s adjustment to a lower growth trajectory being a controlled affair, the global economy remains in decent shape. Rather than major growth disappointments, the big shocks over the last six to nine months have come from markets. Since the summer there have been huge moves in two of the world’s most important prices: both crude oil and the euro exchange rate have plummeted. Crude oil remains...

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    Let's Watch That Movie Again

    The beginning of the year can be a sleepy time for China watchers, what with the short daylight hours, long holidays and a dearth of economic data releases. In this season, even the most earnest reader of tea leaves can be forgiven for dozing off for a bit. But if you fell asleep watching the China economy channel, you didn’t miss much: it was just playing reruns.

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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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    Strong Economy, Weak Markets

    The US has been dishing out report after report showing an improving labor market. And the equity market doesn’t like it one bit.

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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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    Aluminum: Coping With Excess Capacity

    The commodity super cycle is finished. After massive and sustained increases during the early part of this decade, prices for most metals are now thoroughly depressed. The one exception to this trend is aluminum—not because its price is not low, but because it never went up strongly during the heights of the commodity boom. In fact this exception only proves the rule that China and supply-side discipline were the key factors behind the boom in...

    0
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    The EM Challenge

    With the US dollar on a tear and expectations hardening that the Federal Reserve will raise interest rates this summer, emerging market currencies are again in the firing line. In recent days, the Turkish lira and Mexican peso have hit all-time lows against the dollar, while the Brazilian real, Indonesian rupiah, Malaysian ringgit and South African rand are also in the toilet. And yet while developing world crises have often followed US...

    0
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    Is The US Dollar Breaking Out? - Louis-Vincent Gave

    Our admittedly unscientific survey of clients across multiple conversations would suggest that the most popular trade of 2013 was to be underweight European equities. That did not work out. When 2014 rolled around, the most popular trade tended to be short long-dated bonds everywhere, but especially in the US. Again, the consensus was wrong-footed. In 2015, the overwhelming consensus trade has been to be long the US dollar; and for now, and...

    2
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    The Land Of Wishful Thinking

    How bad can Brazil get? Much, much worse. A visit last week for a round of discussions with investors, government officials and scholars confirmed an extraordinary deterioration in Latin America’s biggest economy in just the last six months, one that is nowhere close to playing out.

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    Gavekal Dragonomics

    CEQ Q1 2015

    Growth momentum will slow further. Headline GDP growth was steady at 7.3% in the fourth quarter of 2014, and the full-year figure barely missed the target of 7.5%, but most indications are that growth is headed lower in 2015. The government’s cut in this year’s official growth target, to 7% from 7.5%, acknowledges this reality.

    0
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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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    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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    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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    5C China: A Slowdown In Currency Internationalization

    As the renminbi’s once-steady appreciation against the US dollar has lost steam, so has the pace of currency internationalization. After doubling in size from early 2013 to early 2014, thanks to strong growth in Taiwan and South Korea, total offshore renminbi deposits have barely increased in recent months. In January, renminbi deposits actually declined by more than 2% in Hong Kong, the currency’s largest offshore center.

    0
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    5C Asia: Asian Currencies Should Be Resilient

    A few years back we developed an Asian currencies indicator to help identify times when it pays to dial back exposure (see this report). The tool monitors six global and regional factors to which Asian currencies are sensitive; included are two volatility tracking indicators, two foreign exchange trend rates (renminbi and yen), the Gavekal global velocity indicator and the OECD Asian leading indicator.

    1
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    Gavekal Dragonomics

    CEQ Q1 2015 - The Price Of Reform Without Openness

    For years, increased openness was the companion of reform. Xi Jinping believes openness is dispensable, and is clamping down on the internet, academia and civil society. His program may work, but bodes ill for the hope that China can become an innovation hub.

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    Gavekal Dragonomics

    CEQ Q1 2015 - China's Climate-Change Turnaround

    China was blamed for the failure of the last big climate-change talks, in Copenhagen in 2009. Will it be able to take credit for the success of the next round, in Paris this year?

    0
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    Gavekal Dragonomics

    CEQ Q1 2015 - How China Will Gain From Lower Oil Prices

    China has surpassed the US as the world’s biggest oil importer. The plunge in crude prices gives it new leverage in its quest to diversify its sources of supply.

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    Gavekal Dragonomics

    CEQ Q1 2015 - The Great Gas Price Conundrum

    For years, China’s problem has been finding enough new supplies of natural gas to satisfy its voracious demand. Now, the critical issue is to get prices right.

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