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    Gavekal Research

    Here Comes US Deflation

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

    0
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    Gavekal Research

    No More Easing Likely

    The latest dump of monthly Chinese economic data was generally soft, but what grabbed headlines was an apparent sharp slowdown in broad credit growth. In fact, a closer inspection shows that the pace of credit expansion remained robust in April and the real issue looking forward is whether policymakers respond by dialing back stimulus policies.

    0
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    Gavekal Research

    Portfolio Construction For Fence-Sitters

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

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    Gavekal Research

    The Chinese Debt Resolution

    China’s chosen development approach of investment-led industrialization meant it was fated to face an eventual debt crisis. Like Taiwan 30 years ago, China has moved from an export-driven economy to one motored by domestically-focused investment spending. Its challenge has been to “rebalance” toward consumption and in the process stop an escalating build-up of debt which funds projects with ever lower returns. Yet so long as China has a...

    0
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    Gavekal Dragonomics

    The Glory Days For Affluent Consumers

    While China’s economy is slowing, growth in some consumer markets is booming. The cause is what we call the “acceleration phenomenon” of rapid growth in affluent households, which is driving surging sales of goods and services they favor. The flipside of the affluent growth story, however, is that more mass-market consumer goods are slowing down.

    0
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    Gavekal Research

    Growth Slows, Affluence Accelerates

    The Chinese economy continues to slow, but the Chinese consumer is alive and kicking. The affluent population continues to grow much faster than either GDP or average household income, fueling rapid expansion in sales of SUVs, foreign travel and affordable luxuries like chocolate, yoghurt and coffee. At the same time, though, the shift into affluence means that growth in demand for more basic consumer goods is slowing from the rapid rates seen...

    0
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    Gavekal Research

    Risk On? Maybe Not

    Equity and oil prices have rallied in true risk-on fashion since the February 11 market trough, and are now back near their highs of late last year. Given this apparent rebound in risk appetite, one might have expected US government bonds to sell off in equally dramatic fashion, with yields climbing back to the 2.2-2.3% levels seen at the end of last year. Instead, there has been no rebound at all. Today, 10-year treasuries yield 1.75%, much the...

    0
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    Gavekal Research

    Heading Passively To The Poorhouse

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

    3
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    Gavekal Research

    The Calm Before The European Storm

    A deal with Turkey to ease Europe’s refugee crisis is close to collapse, Greek bailout negotiations are set to test German political resolve and Britain’s referendum on European Union membership is too close to call. Europe’s “project” has been held together since 2012 by extraordinary monetary policy which has spurred a mild economic recovery, observable in the latest data. The concern now is that growing centrifugal forces—mostly political in...

    0
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    Gavekal Research

    Trump And The Tree People

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

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    Gavekal Dragonomics

    Is The Rumpus In The Bond Market Over?

    After a long rally, China’s onshore bond market has finally had a correction. Corporate bonds are experiencing a repricing of credit risk after a recent jump in defaults, and this could go on for a while. But the rise in government bond yields should be a buying opportunity, as China’s interest rates are still headed down over the medium term.

    3
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    Gavekal Research

    Disaster Averted Is Not Success

    This week Atlante, Italy’s new private sector bail-out fund, swung into action for the first time, supporting an equity issue by the troubled Banca Popolare di Vicenza. But although Atlante’s market debut could be said to have averted a potential systemic disaster, it was hardly the success either the politicians of Rome or the financiers of Milan had been hoping for.

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  • Gavekal Research

    Asia’s Best Market Reaches A Precipice

    The Philippines has since 2011 morphed into a balanced development story with growth averaging about 6% Growth has been underpinned by robust domestic demand, and it has also benefited from a long period of fairly trouble-free governance so when Filipinos go to the polls on Monday to elect a replacement for the President, much is at stake.

    1
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    Gavekal Research

    Peak Hubris?

    With a few notable exceptions, it’s been a tough few weeks for technology firms; the likes of Microsoft, Intel, Alphabet, TSMC, Sony, Panasonic, Fanuc, Murata and, of course, Apple all released weak earnings and guidance. Behind the disappointments sit different causes, ranging from weak capital spending across Asia (Fanuc), to a less eager Chinese consumer (Apple), to a still prudent Japanese consumer (Sony) and a stronger yen (Murata,...

    0
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    Gavekal Dragonomics

    AMCs Are Back: More, Smaller, Shadier

    As the bad loans of China’s banks mount, many wonder how the government will deal with the problem. In the 1990s, four big asset management companies led the bank cleanup, and recently a new crop of smaller local AMCs has emerged. Yet these AMCs do not seem to be helping banks resolve bad loans, but instead are helping them hide problem debts.

    1
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    Gavekal Research

    US Homebuilders Hit A Speed Bump

    Homebuilding has been a reliable contributor to US growth over recent years. Now tighter lending standards for new construction projects and commercial real estate loans are threatening a slowdown. But, as KX and Will argue, as long as mortgage rates remain low and demand robust, the sector should only hit a speed bump, not a wall.

    3
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    Gavekal Research

    Making Sense Of The Rally In Cyclicals

    By all accounts, 2016 has so far proved to be a challenging year for “market neutral” funds, and “smart beta” strategies, along with various quant funds. Before we have even reached the seasonally-challenging part of the year—sell in May and go away, and all that—a quick glance at year-to-date returns for “low volatility” hedge funds illustrates that the pain is pretty widespread. In a sense, this is surprising; after all, spreads are tighter...

    2
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    Gavekal Research

    The Gavekal Monthly: Glass Half Full Or Glass Half Empty?

    The past month has seen the US dollar seemingly top out, the oil price settle into a trading range and China’s economic outlook stabilize. Emerging markets in particular have bolted higher despite weak global trade, an oversupplied commodity complex and worries about high levels of leverage. In this edition of The Gavekal Monthly we ask a pressing question for EM investors: is the glass now half full, or half empty?

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    Gavekal Research

    Can The BoJ Ever Do The Right Thing?

    Another Bank of Japan meeting, another market slump. Yesterday saw investors mortified by a BoJ tease which came to nothing, while in January the same market response followed an activist move to charge a negative interest rate on a small part of banks’ reserves. In response to the disappointment the yen soared against the US dollar with its biggest daily move in seven years, while the ensuing six hours saw a 7% peak-to-trough move in Nikkei...

    0
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    Gavekal Research

    Is France “Getting Better”?

    He was not quite Reaganesque in his cheery optimism, but in a recent primetime television appearance President Francois Hollande did declare to France that life was “getting better”. He could point to growth rising to 1.1% last year from a meagre 0.2% in 2014. Unfortunately, the French jobless total hit a new record of 3.6mn in February contributing to a public response of general derision, not to mention rioting at proposed labor market reforms...

    5
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    Gavekal Dragonomics

    The Future Of China’s Oil Demand (II)

    Stockpiling has become a key driver of China’s crude oil imports, as Beijing builds up its strategic petroleum reserve and as state-owned oil companies add to their own inventories. But constraints on the capacity to store these stockpiles mean that this boost to oil imports will likely stall within the next two to three years.

    0
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    Gavekal Research

    Vertigo And The US Economy

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

    3
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    Gavekal Research

    A European Sinner Repents

    When Brussels implemented new solvency rules for European insurance companies in 2014, it committed one of the five cardinal sins of government: over-regulation. Of course, stricter rules were always likely following the financial follies of the pre-crisis era, but when they drew up the new “Solvency II” regulations, the European Union’s generals were so focused on fighting the last war, they failed to realize the danger posed by their own...

    0
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    Gavekal Research

    Asian Plowshares Into Swords

    Japanese Prime Minister Shinzo Abe invested time and prestige in a failed bid to supply Australia with 12 new attack submarines and service them for the next 50 years. It was announced yesterday that the approximate US$38bn contract was scooped by a rival French bidder due to its technical competence, but also after a strong lobbying effort by China which does not want to see a resurgent Japanese defense sector. Canberra’s decision represents a...

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  • Gavekal Dragonomics

    The Future Of China’s Oil Demand (I)

    While China’s demand for coal and other basic commodities has gone into decline, its consumption of crude oil has continued to climb. Rosealea projects the GDP intensity of different oil products to conclude that China’s demand for crude oil is set to continue rising over the next five years, despite the slowdown in many sectors of the economy.

    0
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    Gavekal Research

    The End Of Asian Equity Market Underperformance?

    With Asian equities having underperformed their global equivalents by almost 40% since 2011, the past five years have not been much fun for regional investors. Encouragingly, however, just as the panic over a possible China currency crisis and economic implosion reached its apex last summer, Asia’s underperformance seems to have abated. Over the following eight month period or so, Asian equities have held their own with a number posting decent...

    1
  • Gavekal Research

    Time To Bet On Sterling And Against Brexit

    If Britain votes to remain a member of the European Union, the moment when the tide turned against Brexit will probably be remembered as Barack Obama’s London press conference on Friday. With a single phrase Obama demolished the Brexiteers’ most powerful economic argument when he noted, with a friendly but remorseless grin, that if Britain chose to detach itself from Europe it would wait “at the back of the queue” for any special US trade deal....

    1
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    Gavekal Dragonomics

    How Long Can This Keep Going On?

    Has China salvaged growth only by inflating a housing bubble? How much tolerance the government has for a surge in housing prices and mortgage debt is a crucial question for judging how long the new construction cycle can last. History suggests the price gains are now strong enough for the government to start cooling things down at the margin.

    0
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    Gavekal Research

    Time Alone Is Not Enough For The ECB

    Stung by attacks on his negative interest rate policy, Mario Draghi yesterday hit back at his critics in Berlin, and pleaded for patience. “Our policies work,” insisted the European Central Bank president. “Just give them time.” Draghi’s plea is unlikely to placate German finance minister Wolfgang Schäuble, who earlier this month blamed negative rates and the harm they have inflicted on savers’ incomes for the success of right-wing populists in...

    2
  • Gavekal Research

    NIRP: Machiavellian Design Or A Policy Mistake?

    In order to make money, Starbucks has little choice but to sell coffee. Ford must sell cars if it hopes to stay open. And Lockheed Martin better get orders for bombs, missiles and planes if it is to remain relevant. But banks do not need to make loans (their stated purpose) in order to make payrolls and pay shareholders a dividend, at least at certain points in the cycle. When the yield curve is steep, banks can borrow money cheaply at the...

    3
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    Gavekal Research

    Emerging Markets Reality Check

    Emerging market assets have enjoyed a powerful momentum-driven rally over the last two months. A more dovish stance from the US Federal Reserve, falling yields, acceptance that the US dollar is no longer strengthening, and a pick-up in commodity prices combined to quell the market’s worst fears and persuade investors that emerging markets were not in fact facing Armageddon. More recently last week’s release of relatively upbeat economic data...

    0
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    Gavekal Research

    The Sum Of All Fears

    As “China implosion” and renminbi devaluation fears have faded, risk assets around the world have enjoyed a sustained a rally led by “China sensitive” assets such as commodities, Asian equities and emerging market high-yield debt. In short, all the assets that were priced for a scenario just short of Armageddon. But following this rebound, what next? The most obvious point is that, with the pick-up in fiscal stimulus, the rebound in construction...

    0
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    Gavekal Research

    Eurozone Reform Update 2016

    Last February we published a detailed score card of the structural reform efforts undertaken by Europe’s battered peripheral economies (see Assessing ‘Thatcherite-Keynesianism’). The last year has seen small improvements, but not enough change to warrant another box-ticking exercise. Our assessment in 2016 mostly focuses on the key relationship between the labor markets and national competitiveness. Inevitably such changes are slow moving and in...

    0
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    Gavekal Research

    Rebalance Away From US Equities

    Yesterday the S&P 500 closed at a year-to-date high of 2,094, up 14.5% from its February 11 low. Now comes the real test of investor confidence. At its current level the index is just 1.7% below its all-time high, set on May 21 last year. Since then the market has tried and failed on four occasions to surpass that level, in June and July, and then following the summer’s sell-off, in November and December. With the market apparently poised...

    0
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    Gavekal Dragonomics

    A Regional Guide To The Property Recovery

    The rebound in real-estate investment is behind China’s growth stabilization, but flies in the face of still-high inventories of unsold housing. The regional pattern is very mixed: some genuine improvement, and a lot of government stimulus. Construction in 2016 will be better than expected, but the lack of destocking will drag on future growth.

    7
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    Gavekal Research

    Worth Buying This Japanese Dip

    Those with an active interest in Asian markets had much to process in early trading with shorts cheered by the hardly surprising news that Iran and Saudi Arabia could not agree on an oil production freeze, while longs could point to China whose 1Q15 GDP report on Friday seemed to confirm that the authorities will do whatever it takes to defend their near-term growth targets. But perhaps the bigger factor unnerving investors has been the fallout...

    0
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    Gavekal Dragonomics

    The Jaws Begin To Close

    China’s growth divergence in 2015 was dramatic. But that divergence is narrowing in 2016, with industry picking up as services slow. While markets have welcomed the stabilization, it’s largely the result of short-term stimulus—and it’s also becoming harder to tell a positive story about the “good” growth drivers of services and consumption.

    1
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    Gavekal Research

    Oil’s Busted Flush

    Buoyant expectations that the world’s major oil producers could agree a production freeze when they meet in Doha on Sunday have helped push the price of crude to a four-month high this week. The international Brent blend benchmark reached just shy of US$45/bbl, up 66% from its late January low of US$27, with at least some brokerage houses predicting the price could breach US$50 in the event of a deal. Maybe—but forecasts that the crude price...

    0
  • Gavekal Research

    Is US Manufacturing A Leading Indicator?

    There is a commonly held belief that US manufacturing leads the rest of the economy, so it is surely a worry that factory output has been flat since late 2014. And yet the broad economy kept growing—with GDP up 2% YoY in 4Q15, consumption up 2.7% YoY, and home construction by almost 10%. One explanation for this apparent decoupling is the US’s shift to a more service-intensive “knowledge economy” which has rendered metal bashing and more...

    0
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    Gavekal Dragonomics

    The End Of Deflation Is Nigh

    China’s growth slowdown has been much worse in nominal terms than in real terms—and often, nominal matters more. So it is good news that both consumer and producer price indexes are picking up in early 2016. And even if commodity prices do no rally further, China’s GDP deflator is likely to turn positive by the second half of this year.

    1
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    Gavekal Research

    The Bright Spot Amid Japan’s Gloom

    The new narrative about Japan is straightforward: Japanese government bond yields will fall even further, the yen will strengthen, corporate earnings will collapse, stock prices will sink, and Mrs Watanabe will withdraw all her savings from the bank and stash them under her tatami. Over the last couple of months, international investors have positioned themselves accordingly. Yet anything more than a cursory visit to Japan quickly emphasizes...

    0
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    Gavekal Research

    From Black Hole To Muddling-Through

    Over the past few months, sentiment towards China has shifted dramatically. Fears that China was a black hole at the heart of the global financial system have morphed into mild optimism, as growth indicators have stabilized. There remain plenty of longer-term problems, but muddling through rather than collapse is the likely scenario for 2016.

    4
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    Gavekal Research

    Hong Kong Seminar Multimedia

    We are pleased to present recordings and slides from our Hong Kong seminar with Louis-Vincent Gave, Will Denyer and Andrew Batson. Louis examines an important recent development: the US dollar has stopped rising. Will diagnoses the health of the US economy in one chart. And Andrew discusses three scenarios for China: doom, boom and muddle-through.

    0
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    Gavekal Research

    No Relief For European Banks

    Yesterday a consortium of Italy’s healthier banks and financial institutions agreed to put up €5.7bn to finance a private sector bailout fund for the country’s weaker banks. The deal, which was cobbled together by Italy’s Finance Ministry, is clearly intended to circumvent European Union rules limiting state aid to the banking sector. Details remain sketchy, however it is difficult to see how the agreement can restore confidence in Italy’s banks...

    0
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    Gavekal Research

    Why India Can Move Faster

    India’s lack of efficient roads and railways lowers productivity, depresses aggregate demand, raises costs and stymies trade—all impediments to economic growth. The good news is that India’s latest infrastructure push, financed initially by public investment, is showing signs of traction. The latest government budget committed a hefty US$32bn to roads, rail and other infrastructure, a big increase within a broader environment of fiscal...

    2
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    Gavekal Research

    Paris Seminar—April 2016

    On April 12 Louis-Vincent Gave, Charles Gave and Jean-Jacques Netter held a seminar in Paris where they presented their latest macroeconomic and investment outlooks.

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  • Gavekal Research

    Updating The US Recession Indicator

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

    1
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    Gavekal Research

    European Disunion

    The grand old men who conceived of a united states of Europe knew that a successful single currency demanded a modern federation with integrated monetary, fiscal and political institutions. Such a leap into the unknown was politically impossible in the 1990s, and their assumption (and perhaps hope) was that the less than optimal eurozone would suffer periodic crises, so creating the conditions for reform and a centralization of powers. Since the...

    3
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    Gavekal Research

    London Seminar—April 2016

    London Seminar—April 2016

    0
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    Gavekal Research

    The Yen And Japanese Equities

    It is hard not to feel a smidgen of sympathy for Haruhiko Kuroda. In the last 18 months, the Bank of Japan governor has deployed a whole battery of heavy artillery, stepping up his asset purchases to ¥80trn a year, extending them to cover exchange-traded funds and real estate investment trusts, and pushing short term interest rates into negative territory. As well as supporting asset markets, much of this effort was aimed at driving the yen...

    0
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    Gavekal Research

    Debt Swaps Are No Panacea For China

    To help troubled borrowers, China’s government is embracing debt-for-equity swaps. But while such swaps will reduce the burden on indebted companies and avoid an abrupt deleveraging, they will also load more stress onto bank balance sheets. Beijing will still eventually have to come up with a workable plan to recapitalize banks; this is not it.

    0
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    Gavekal Research

    The Slowdown In Services

    Both the main leading indicators of activity in the US services sector—the ISM services PMI and the Markit services PMI—staged modest rebounds in March. But on the face of it, the pick-up in the headline numbers offers little encouragement for investors. At 54.5 for the ISM and 51.3 for Markit, both measures remain substantially below their 2015 averages of 57.2 and 55.9 respectively. Considering that services make up 70% to 80% of the US...

    0
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    Gavekal Research

    Why US Imports Are Disappointing

    Given the strength of the dollar, it is not surprising that 2015 generally saw US exports contracting, US imports growing, and the trade balance widening. What is more perplexing is that import growth has started to look shaky in the first part of this year. What gives?

    0
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    Gavekal Dragonomics

    CEQ Q1 2016 - Powerhouse, Menace, Or The Next Japan?

    Two popular narratives about China are that it will either reform its economy and become the next superpower, or fall victim to a dramatic financial crisis. There is a third and perhaps more likely scenario: gradual stagnation, along the lines of 1990s Japan.

    0
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    Gavekal Dragonomics

    CEQ Q1 2016 - China's Impending Minsky Moment

    The Chinese authorities have given up even trying to geta handle on the country’s spiralling debt problem.This means that a financial crisis and severe growth downturn are likely by 2020.

    0
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    Gavekal Dragonomics

    CEQ Q1 2016 - The Fall Of Productivity And The Rise Of Debt

    Productivity of capital is falling, and debt is rising. Does this mean China is headed for low-growth, high-debt stagnation? Not necessarily. Economy-wide returns on capital remain solid; the biggest problems are an inefficient state enterprise sector, and excessive infrastructure debt. Strong state enterprise reforms could enable growth to stabilize at a high level.

    0
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    Gavekal Research

    Fade The Emerging Market Rally

    In defiance of conventional wisdom the oil price has tumbled -10% in the last two weeks despite a weak US dollar. For emerging markets investors, the breakdown of this correlation raises tricky questions.

    0
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    Gavekal Dragonomics

    CEQ Q1 2016 - Excess Capacity, Zombie Companies, And Debt Deflation

    The story goes that excess capacity and debt-ridden ‘zombie companies’ will drag down China’s economy. But the problems are mainly confined to steel, coal, and other construction-related industries—and are less dire than in the 1990s. A long, slow restructuring is possible, though perhaps not ideal.

    0
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    Gavekal Dragonomics

    CEQ Q1 2016 - What We Learned From The Stock Market Crash

    The mess that are China’s stock markets cost securities regulator Xiao Gang his job in early 2016. Sacking him was the easy task. The real work remains to be done if the country’s financial markets are ever to fulfil a real role as an allocator of capital.

    0
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    Gavekal Dragonomics

    CEQ Q1 2016 - The End Of Non-Interference

    China’s Strong Arm: Protecting Citizens and Assets Abroad by Jonas Parello-Plesner and Mathieu Duchâtel (International Institute for Strategic Studies, 2015)

    0
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    Gavekal Dragonomics

    CEQ: Avoiding The Japan Trap

    Growth is slowing, debt is rising, and the government is openly talking about "zombie companies" in key industries. This is China today, but there are also echoes of 1990s Japan. This issue of the CEQ examines the similarities and differences, and handicaps China’s chances of dodging a Japanese scenario of low-growth, high-debt stagnation.

    0
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    Gavekal Research

    The Case For Sterling

    What was the weakest major currency in the world in the first quarter? It was not the Brazilian real nor the Australian dollar nor any of the other usual suspects among the emerging market and commodity currencies. That accolade went to the British pound, which managed to depreciate by -4%, from US$1.48 to US$1.42, even while the dollar itself fell another -5% on its trade-weighted index.

    2
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    Gavekal Research

    Marginal Analysis In Capital Markets

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

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  • Gavekal Research

    Things Fall Apart

    Over the past century periods of social breakdown have swung the pendulum of power from markets to governments and back. Each crisis ended with a transformation in economic and political thinking. Today, voter anger is a response to the 2008 breakdown of deregulated capitalism. This time, argues Anatole, politicians must reconsider the market fundamentalism that has prevailed in recent decades and design a new system of checks and balances to...

    12
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    Gavekal Research

    The Gavekal Monthly: The Dollar Weakens; Time To Buy Jewels?

    The big change over the last month is that the US dollar is now falling on a year-on-year basis. This weakness reflects a more abundant international supply of dollars as the US trade balance, ex-China and ex-oil, has swung back into the red after six years in surplus. In this edition of The Gavekal Monthly, Louis outlines why, in such a plentiful-dollar environment, investors should consider prioritizing “jewels” over “tools”.

    0
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    Gavekal Dragonomics

    How Big Is The Zombie Army?

    China’s economy is reportedly being dragged down by an army of “zombie” companies—unprofitable firms clinging to life through subsidies. In fact, the data show only about 10% of Chinese firms are truly financially troubled. “Zombies” look less like a huge systemic problem and more like a normal effect of the downturn in housing and heavy industry.

    6
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    Gavekal Research

    The Beef In Japan’s Budget Bowl

    At ¥97trn, the 2016/17 budget passed by the Japanese parliament on Tuesday was the country’s biggest ever, with accelerating spending increases for welfare, pensions, healthcare, and defense. Yet no one expects Tuesday’s budget to be the end of this year’s fiscal story. Greater than expected increases in tax revenues both from corporations and individuals mean the budget’s reliance on funding from Japanese government bond issuance fell to 35.6...

    6
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    The China Factor In The Fed’s Equation

    Janet Yellen yesterday confirmed that uncertainty over the global outlook was why the Federal Reserve scaled back expected interest rate hikes. But just what happened in the world to change her mind? Rather than slightly weaker global growth prospects, market turbulence is the more likely culprit—in particular the stress over China’s currency.

    0
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    Bridging India’s Financing Gap

    India’s shoddy infrastructure is the stuff of legend. Ranked 87th in the World Economic Forum’s infrastructure quality index, much of it would not look out of place in sub-Saharan Africa. Mumbai’s rickety old airport, famous for its frequent delays and scuttling rats, once told visitors everything they needed to know. Yet the city’s sleek and airy new terminal presents a fresh image: five times bigger than the old airport, it is clean, efficient...

    2
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    Returns On Capital Are Deteriorating

    The rate of return on capital invested in the US has taken another step down. While not terribly surprising, this does bring the world’s largest economy one step closer to the next recession and a full-scale bear market. Nevertheless, the day of reckoning remains some way off; the current cycle is not about to reach the end of its road just yet.

    0
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    Gavekal Dragonomics

    Macro Update: Of Stimulus And Stability

    Our quarterly overview of China’s economy reviews the eventful start to 2016 and reassesses the outlook. The renminbi has returned to relative stability, property is picking up again, and stimulus is continuing. But growth is still reliant on state spending, national leverage is still rising, and services and consumption are set to weaken.

    0
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    Gavekal Dragonomics

    No Worries From China's Rebalancing?

    For a country that gained so much from China’s commodity boom, Australia seems quite sanguine about the bust. Mining investment may be falling, but optimism on tourism is rising. So has Australia already switched from the old commodity-driven to the new consumer-driven China? And will this rebalancing also be painless for the rest of the world?

    0
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    US Housing: From Great To Good

    The US housing recovery properly kickedoff in 2011 as a confluence of benign factors converged to favor the sector. Yet while housing continues to provide a much-needed positive contribution to US economic growth, recent data points to reduced momentum. After a weak January, homes sales for February, released yesterday, ticked a little higher. Yet over the last year, sales have been choppy and generally flat. The NAHB index also shows...

    2
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    Europe’s Reflation Trade

    Yesterday’s awful events in Brussels offer a stark reminder of our personal vulnerability in an unstable world and our hearts go out to the victims. They also reinforce liberal Europe’s vulnerability to hate-based ideology and highly motivated terrorists. However, we at Gavekal are economic analysts rather than geopolitical experts, and today want to focus on a more constructive view of Europe—namely, its equity market. After a knee-jerk sell-...

    0
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    The Fed’s Price Keeping Operation

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

    1
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    Gavekal Dragonomics

    Five Trends From The Five-Year Plan

    What to make of China’s five-year plan? The 13th and most recent plan has lost some uniqueness: it is now just one of Xi Jinping’s many long-term plans, strategies and initiatives. So figuring out what is new and important can be even more challenging. To cut through the clutter, we highlight five important trends for next five years.

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    Gavekal Research

    Dollar Liquidity And Its Dependents

    One of our long-standing rules of thumb has been that a deteriorating US trade balance is good news for the rest of the world, and especially for emerging markets. It is thus a positive sign that the ex-energy, ex-China trade balance shifted from surplus to a deficit in 2015, sending US$150bn to the world outside of China and the oil exporters. The overall trade balance is likely to continue worsening through late 2017, thanks to the lagged...

    5
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    Gavekal Research

    We Are Killing The Wrong Pig

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

    6
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    The Road To Reflation

    For the last ten years or so, ever since the Hartz reforms to the German labor market, Germany has been by far the biggest driver of overall eurozone growth. Indeed, for much of 2012, Germany was the only driver of eurozone growth. This has not been a healthy phenomenon. With German savings rates high, and domestic consumption sluggish, much of Germany’s own growth was propelled by its net exports of goods to the rest of the world beyond the...

    1
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    The Fed Is Falling Behind The Curve

    The Federal Reserve surprised no one yesterday when it decided to remain on hold. But the downward shift in its projection of year-end inflation from 1.6% to 1.2%—and the consequent revision of its dot plot to show two, rather than four, rate hikes in 2016—should have raised a few eyebrows. By adopting such a dovish stance, the Fed is in increasing danger of falling behind the curve on inflation, which in turn implies that the risk of sharper...

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    The Bloodhound And The Swedish Economist

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

    7
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    Gavekal Research

    China’s Buying: It’s A Good Time To Sell

    A flurry of big cross-border mergers and acquisitions by Chinese companies has left many people scratching their heads. Announced Chinese international acquisitions are on track to exceed US$100bn in the first quarter—almost as much as in the whole of 2015. What is driving this torrent of cash?

    1
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    Gavekal Research

    The Upside In India

    The biggest immediate problem is that corporate India is not investing. Private businesses are over-leveraged and economic demand is weak. Hamstrung by US$130bn of bad loans, India’s state banks aren’t lending. The government has made little headway on the long-running debate over how to clean up their overstretched balance sheets.

    0
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    Super Mario: Hero To Zero To Hero

    As markets plunged following Thursday’s European Central Bank meeting, it seemed as if Super Mario had turned into Dumb Draghi.But by Friday morning Draghi had again gone from Zero to Hero, with risk-on assets racing ahead in virtually every market around the world.

    2
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    Gavekal Dragonomics

    A Turn Too Soon

    The biggest surprise in China’s latest data was the rally in property: housing sales surged and real estate investment picked up in the first two months of 2016. But this improvement is unlikely to be sustained: the turn in property has come far earlier than fundamentals warrant, and suggests the government does not have a firm grip on the market.

    2
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    The End Of The Road

    The European Central Bank pulled the trigger but the bazooka misfired. European stocks peaked half an hour after yesterday’s new easing measures were announced, but investors quickly focused on the broader significance of the action.

    1
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    Gavekal Dragonomics

    What To Make Of Industrial Layoffs

    When China’s labor minister said the troubled coal and steel industries could shed 1.8mn jobs, the news provoked a lot of excited commentary. But this is not 1998 all over again. The government’s layoff plan does not mean China is about to be swamped by a wave of unemployed workers, nor that officials are “getting serious” about excess capacity.

    2
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    Gavekal Research

    The Yen And Hard Truths

    The renewed “risk-on” moves of recent weeks has seen a vicious rebound in commodity prices, renewed stability in credit markets and, notably, a decline in the euro, which has fallen back to its early year level against the US dollar. The big outlier in these moves is the Japanese yen, which has become the new strong man of the currency world.

    0
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    Charles Discussing His Recession Indicator

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    Draghi’s Difficulty

    When the European Central Bank’s governing council meets tomorrow, Mario Draghi and his colleagues will find themselves facing a dilemma. With growth sluggish, and inflation elusive, the consensus expects the ECB to ease its already ultra-loose monetary policy further. Likely steps include cutting the central bank deposit rate by 10bps to -40bps, increasing bond purchases to €70bn a month from €60bn, and extending the program of purchases beyond...

    0
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    A Diagnostic Tool For Bear Markets

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

    7
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    Gavekal Research

    Parsing The Decline In China’s Reserves

    After falling by almost US$300bn in the three months to January, China’s foreign reserves showed signs of stabilizing in February. The slower pace of decline is certainly welcome news for the central bank. But the reduced stress owes a lot to recent dollar weakness, and it is too early to say Beijing is fully in control of its new currency regime.

    0
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    The State Of US Profits

    With the US earnings season for 4Q15 done and dusted it is clear that the glory days of this cycle are long gone: aggregate sales for S&P 500 firms fell -4.0% YoY, profits tumbled -7.5% and margins for the period (not the trailing measure) compressed by -2.2pp to 6.5%. The big drivers of profits were (i) the oil price collapse, (ii) the strong US dollar and its crimping of exporters, and (iii) the tendency for rising wages to erode margins....

    0
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    Reality Check In Brazil

    After a year of terrible news, Brazilian markets rallied last week on the surprise news that former president Lula Ignacio da Silva had been forcibly hauled in for questioning by investigators plumbing a vast and fetid corruption scandal. On the hope that Lula’s brief detention presaged his arrest and the fall of his hand-picked successor, the widely despised president Dilma Rousseff, equities gained 8% in two days and the beaten-down real...

    1
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    Gavekal Dragonomics

    Papering Over The Credibility Gap

    The aura of technocratic competence that once surrounded China’s leadership is tarnished these days. A recent burst of transparency from top officials has not done much to change that. The bigger problem is that the government has locked itself into a growth target that is not credible, which makes all economic policy less credible.

    0
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    Dissolving The People

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

    9
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    Gavekal Research

    Not Yet The Buy Of A Lifetime

    With emerging market equities up 13% over the last three weeks, and outstripping developed markets over the year to date, the notion is gaining traction that after four years of underperformance emerging markets are now “the buy of a lifetime”. Investors should be cautious. While it is indeed possible that emerging markets could continue to rally over the next few months as the US dollar tops out and commodity prices stabilize, the longer term...

    2
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    Gavekal Dragonomics

    Where Is The Value In A-Shares?

    With the Shanghai market down by nearly half from its peak, are Chinese A-shares starting to get cheap? Unfortunately no: most stocks other than banks are still highly valued. But technology and healthcare firms, many of which trade in Shenzhen, are still good growth stories, and are cheaper relative to the market than they have been for years.

    0
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    Back To Climbing The Wall Of Worry

    Just three weeks ago markets were in full-blown panic mode. The S&P 500 was down -10% YTD, 10-year treasury yields were down to just 1.6%, and credit spreads were close to their cyclical highs. Dark clouds seemed to be rolling in on every front—from China, Brazil, Europe, banks, and the energy sector, all compounded by fears the Federal Reserve had made a grievous policy error. Since then, the skies haven’t exactly cleared, yet the S&P...

    0
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    Too Quiet On The Southern Front

    Since the euro crisis kicked off six years ago, policy decisions affecting banks have had two main goals. Whether it be monetary policy, the 2014 asset quality review or moves toward both a banking and capital markets union, the objective has been to boost confidence in the system and reduce the fragmentation of credit markets. A -20% fall in eurozone bank shares YTD on concerns about the impact of negative interest rates shows that the first...

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