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    Gavekal Research

    QE & Bull Markets

    A client recently asked a deceptively simple question: does quantitative easing always lead to a bull market in financial assets? There was, of course, a background context to the enquiry which was last week’s much anticipated deflation-slaying action by the European Central Bank.

    3
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    Gavekal Research

    Stagnation, Default Or Devaluation

    Last week’s Jackson Hole meeting helped to highlight a simple reality: unlike other parts of the world, the eurozone remains mired in a deflationary bust six years after the 2008 financial crisis. The only official solutions to this bust seem to be a) to print more money and b) to expand government debt. Meanwhile, Europe’s already high (and rising) government debt levels and large budget deficits raise the question whether we should worry...

    0
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    Gavekal Research

    Five Corners (20 August): Velocity Of Money

    In the latest bi-weekly review of global economics and investment we focus on the velocity of money and the credit cycle in the major economic regions: Overview: Charles Gave notes with concern the downturn in the Gavekal Velocity Indicator. US: Will Denyer looks where the US is in the credit cycle and argues it looks more like 2004 than 2007. Europe: François Chauchat argues that contrary to popular belief Europe’s long credit crunch is...

    0
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    Gavekal Research

    The Cantillon Effect (And The Inevitable Demise of Financials)

    Richard Cantillon, an Irishman who spent much of his life in France, only wrote one book (Essai sur la Nature du Commerce) that was published after his death in the early 18th century. It proved a groundbreaking text in the history of political economy and had a huge influence on the likes of Knut Wicksell, the Austrian school and the great Irving Fisher.

    5
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    Gavekal Research

    A Spectacular Eur-Asian Divergence

    Financial markets are nothing if not a real time survey of real people playing with real money. Hence, no one can seriously doubt that markets contain a huge amount of highly pertinent information. The problem for the investor is how can this be profitably extracted?

    6
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    Gavekal Research

    5C Overview: Time For The Defensive Team

    In the second half of last year I wrote a number of pieces that addressed the “velocity of money.” Regular readers will be aware that Gavekal places great store on this particular economic measure (defined as the willingness of the financial sector to take risk) as a key driver of asset prices.

    0
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    Gavekal Research

    What Is The ECB Waiting For?

    Banking networks have typically been built on two elements: confidence, and capital. Historically, confidence was often based on the common background of the bankers—the Lombards in Italy and France, Jews in Spain. Otherwise it relied on an institution willing to take on transfer risks (for a fee) and large enough to reassure payers that it was ‘too big too fail’; for example, the great monastic orders of the Middle Ages.

    1
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    Gavekal Research

    Simple Rules For Asset Allocation

    In our research, we have always made two major assumptions. The first assumption is that assets can have value for one of three reasons:

    2
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    Gavekal Research

    Stock Markets And Profits

    Over the long term—and I mean the really long term—stock markets and corporate profits tend to track each other nicely. Consider the chart below which with a base in 1970 shows the S&P 500 and US profits from the national accounts adjusted for inventories and capital depreciation.

    2
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    Gavekal Research

    How And When To Short French Bonds

    Earlier this month I recommended—for the first time in my career—an unhedged short position in the French bond market (see It’s Time To Go Short French Bonds). For investors who are uncomfortable with such ‘naked’ shorts, there may be an alternative. They could go short the French OAT and go long the German bund. This Daily sets out the risks involved, together with a decision rule to determine timing.

    2
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    Gavekal Research

    The Price Of A Diminished US Dollar

    Nature, it is said, abhors a vacuum. In much the same way, geopolitics cannot tolerate a power vacuum. So it is small surprise that as a chastened and diminished United States has retreated from direct involvement in the Middle East and adopted a less interventionist diplomatic and military stance elsewhere in the world, ambitious opportunists have stepped forward to fill the gap. In East Asia, China has assumed a far more assertive attitude...

    2
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    Gavekal Research

    Indexation = Parasitism

    The role of financial markets is to evaluate in real time the marginal return on capital of different assets. This is done through a ‘price discovery mechanism’, with the ‘right price’ found out through a system of constant trial and error. To discover this price calls for a community of active money managers, each doing his or her due diligence before buying and selling. This price is a function of the return on capital and of the expected...

    14
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    Gavekal Research

    It's Time To Go Short French Bonds

    Monday is le quatorze juillet, July 14, France’s national day. In Paris a grand military parade will march along the Avenue des Champs-Élysées as air force jets streak overhead to mark the 225th anniversary of the French Revolution. Yet, behind the pageantry celebrating the glories of the republic, all is not well. For two years I have maintained that France has been facing a secondary depression. As expected, the economy is now getting worse,...

    6
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    Gavekal Research

    Poverty Matters For Capitalists

    Inflation is a much misunderstood phenomenon. Most people assume that a CPI rate of 10% means that most prices are rising by a similar amount. In reality, some prices may be falling even while others soar. This matters because price variations affect socio-economic groups in very different ways. The rich tend not to be impacted unduly by price hikes for “necessities” such as food, rent and fuel, while the impact on the poor is to slash that...

    17
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    Gavekal Research

    What Lurks Beneath

    This week has seen the conviction of both bulls and bears tested. Job creation in the US exceeded expectations in June and so investors yesterday bid the S&P 500 to yet another high. Bulls probably took succor from Janet Yellen’s mid-week promise not to use the blunt instrument of interest rate rises to prick any irrational exuberance. Yet, earlier in the week, bears must have looked approvingly at a Bank for International Settlements report...

    3
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    Gavekal Research

    The Emerging German-Russian Axis

    This weekend has seen the European Union do a stitch-up deal so that arch-federalist Jean-Claude Juncker became Commission president. To be honest, who gets to play eurocrat in chief is of no great interest to me, but the manner of the appointment tells us lots about the changing nature of power in Europe. Governments from Stockholm to Rome reportedly opposed Juncker, but ultimately none would defy Berlin. Also this weekend, it is worth noting...

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    Gavekal Research

    5C Overview: Time To Exit Illiquid Credit

    “The essence of shadow banking is to give liquid claims on illiquid assets” — Jeremy Stein, Federal Reserve governor until May 28, 2014.

    2
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    Gavekal Research

    Sunnis On The March

    It is clear that we are seeing a major conflagration in the Middle East along the deep-rooted Sunni-Shia divide. But beyond the great schism of Islam, the breakdown of national borders that have broadly held since the 1918 Franco-British carve-up of the Middle East is again being dictated by great power politics. This is the story behind the Islamist surge through central Iraq this week. It is likely to have significant consequences beyond the...

    2
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    Gavekal Research

    BNP, Big Brother And The US Dollar

    France’s biggest bank, BNP Paribas, and the US government have gotten into a fight—a fight which threatens to cost BNP US$10bn in fines and possibly even its US banking license. As usual, the official causes of the fight have very little to do with the real ones. The official narrative goes like this: the US government placed embargos on a number of countries, including Sudan, Cuba and Iran. Between 2002 and 2009, BNP’s subsidiary in Geneva,...

    6
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    Gavekal Research

    Tomorrow Is Not A Game Changer

    Tomorrow we expect to see the latest Band-Aid solution being applied to the eurozone. Having teased the market for months, it seems likely that the European Central Bank will trim its main refinancing rate, possibly announce a negative deposit rate and even promise a few asset purchases. Forgive me if I don’t roll out the barrel. This is fiddling which does little to correct the fundamental dysfunction at the heart of the system. Let’s be clear...

    1
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    Gavekal Research

    Long Bonds Are Past Their Best

    I am surprised and a little bit mystified. Over the last few days, I have read article after article saying that this year’s decline in US long term rates was totally unexpected, and that the behavior of the bond market has prompted many financial firms, and even the US Federal Reserve, to throw away the econometric models they used to forecast long rates.

    5
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    Gavekal Research

    Playing The Bond Markets In A Fixed Exchange Rate System

    Contrary to what some people may believe, I do not wake up in the morning with an irresistible urge to short the French bond market, or to go long US treasuries, or whatever it happens to be. I devise decision rules and I follow them. To build these rules, I always follow the same steps.

    0
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    Gavekal Research

    A Return To Old Faithful

    Like obscenity and modern art, most economic data charts, and market data charts will mean different things to different people. For example, earlier this week Will Denyer argued that investors should sell US treasuries due to the uptick in US inflation, a moderately optimistic outlook on economic growth and the fact that 10 year bonds seem to be flirting with an important level (2.5%) from which they have bounced in the past (see Time To Sell...

    1
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    Gavekal Research

    A Supply-Sider’s View Of China

    Let’s conduct a simplified thought experiment. Imagine a country where there are two types of capex: capital spending used for building infrastructure and capital spending deployed in favor of other private sector activity. By rights, money should go to those projects with the higher return on invested capital. The problem is that most returns from infrastructure accrue to third party users of the asset (so called “externalities”) and not to its...

    6
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    Gavekal Research

    The Problem With Piketty

    Thomas Sowell coined a marvelous phrase to describe the well-intentioned social engineers who always know what needs to be done to improve the wellbeing of the downtrodden. He called them “the anointed” and explained how their reasoning always evolves in the same three stages:

    13
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    Gavekal Research

    Will The Last Businessman To Leave France Turn Out The Lights?

    This week the French government announced its opposition to GE’s proposed US$13.5bn acquisition of Alstom’s energy business, even though the bid won the approval of Alstom’s board. Instead ministers have indicated their preference for a rival deal with Germany’s Siemens. Either way, Alstom’s energy arm will still pass into foreign control, becoming just the latest in a long string of businesses to quit France.

    7
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    Gavekal Research

    A Supply-Sider’s View Of Japan

    Two years ago respectable opinion had it that the United Kingdom’s economic outlook was pretty bleak. After all, the Conservative-led government had adopted a policy of public spending cuts, which every right minded person knows must lead to insufficient aggregate demand and a descent to oblivion. My somewhat unfashionable take was that these spending cuts had laid the ground for a sustainable pick-up in private sector activity (See An...

    4
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    Gavekal Research

    Obamacare And US Growth

    Regular readers will know that I am not a great fan of GDP as a measure of a nation’s wealth creation capacity. Firstly, the numbers are so heavily revised that their value is dubious. More substantively, there is the question of what GDP measures. In the private sector, transactions are entered willingly and all costs are deducted before arriving at the sum of the added values—when a private sector entity makes a loss, that sum is deduced from...

    4
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    Gavekal Research

    Easy Eurozone Trades Are Running Out Of Road

    Investor enthusiasm for government debt from the eurozone’s southern periphery persists unabated. Last week the yield on Spanish 10-year bonds dropped to its lowest level since September 2005. Before too long, however, I believe investors will find themselves bumping up against some hard truths imposed by simple accounting identities. In this I find myself taking a somewhat different view to the one recently expressed by François (see Believe In...

    3
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    Gavekal Research

    Five Corners (16 April 2014)

    In the latest bi-weekly review of global economics and investment, Charles Gave explains why it still pays to run a balanced portfolio, despite the market’s rotation. Will Denyer argues that outlook for US consumption remains favorable, even though consumer cyclicals have taken a beating. François-Xavier Chauchat examines the reasons behind the euro’s persistent strength. Andrew Batson looks at Beijing’s new focus on jobs and finds the...

    0
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    Gavekal Research

    5C Overview: Why A Balanced Portfolio

    Last August I suggested moving from a fully invested position in equities to a “balanced portfolio” with equities hedged by high quality government bonds. What underlay this recommendation was a simple reality: the global consumer price index had by that point dipped to about 3.3% and the G7 core CPI measure was down to 1.1%.

    0
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    Gavekal Research

    The Euthanasia Of Pensioners In Peoria

    I read everywhere that the US budget deficit is contracting because government consumption is falling as a percentage of GDP, now that the worst of the crisis has passed. This would be very good news indeed, however, I am not so sure that this decline is for real. In fact, I believe it is an accounting illusion.

    1
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    Gavekal Research

    5C Overview: In Defense Of The Inverted Yield Curve

    Capitalism is inherently deflationary because private capital is subject to the creative destruction process. By contrast, government spending is naturally inflationary as it is not subject to the same competitive erosion and deficits that are funded by a government controlled central bank.

    0
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    Gavekal Research

    The Sword Is The Axis Of History

    As Anatole recently argued, we can all breathe a sigh of relief that the tussle over the Crimea has likely been resolved without serious bloodshed and at minimal cost (see All Over Bar The Annexation). But in the longer term it is clear that these events may cast a long shadow over international relations for years to come. Indeed, as British politician Ernest Bevin famously said, “don't open this Pandora’s box, it is full of Trojan horses...

    2
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    Gavekal Research

    Southern Europe’s Unavoidable Deflation

    Last week we published a piece by Francois which argued that a “reflating” Southern Europe was close to exiting its debt trap nightmare, while the promise of further counter-measures by the European Central Bank meant that Europe faced no serious deflation risk. I would respectfully differ, and in this paper will seek to show that Southern Europe is sliding further into a “secondary depression,” which is likely to worsen just so long as the...

    3
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    Gavekal Research

    How To Think About Deflation

    The word deflation is appearing in newspapers almost every day, while the International Monetary Fund and the OECD, the rich world club, are falling all over themselves to see who can most frequently use the phrase “deflation risk.” As I have been warning about deflation for quite a while—and feeling like a voice crying out from the desert—I have naturally been interested to read what these fellows have to say on the subject. Unfortunately,...

    6
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    Gavekal Research

    Gold As A 'Deflation' Hedge

    Economists have had many market puzzles to ponder in this era of monetary excess, going back to Alan Greenspan’s long bond “conundrum” nearly a decade ago. The latest market conundrum is gold: why did it begin rallying on news that US liquidity growth would be slowing (the taper), and why has it remained strong despite weak global CPI prints and flagging broad money growth the world over. This is particularly hard to understand for OECD...

    4
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    Gavekal Research

    The US Current Account And Vanishing Global Liquidity

    The US dollar is the world’s reserve currency which in simple terms means that the United States is the only country which can settle a foreign deficit by issuing its own money. As such, any “improvement” in the US current account balance means that fewer dollars show up outside of the US, while the reverse holds true in the event of a deterioration.

    0
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    Gavekal Research

    5C Overview: Volatility And Balanced Portfolios

    My big worry over the last year has been a descent into deflation due to Federal Reserve policies that have caused the velocity of money to crater. However, economic history tells us that deflation does not in all instances mean depression. After all, there have been many cases of prices falling and economic activity rising, which is a phenomenon that we have labelled as a “deflationary boom.”

    0
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    Gavekal Research

    Leading Indicators Through The Looking Glass

    Leading economic indicators are a key tool used by analysts to gain a heads up on the future. They rely on a mix of hard and soft survey data and offer a glimpse of likely spending decisions to be made by producers and consumers. That, at least, was the way things used to work in Europe. Today, the impact of multiple policy manipulations is that the predictive power of these tools has almost completely broken down (see The Problem With Leading...

    9
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    Gavekal Research

    The Emerging Market Crisis

    With emerging markets in panic mode, investors are bound to be reminded of the enduring observation, first made by a 19th century British businessman named John Mills, that: “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal in hopelessly unproductive works.” With that in mind, investors seem happy to link the ongoing EM sell-off to either a) China's large capital...

    4
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    Gavekal Research

    Portfolio Building In The Time Of Disinflation

    Stocks and bonds are the two main financial assets. The return on stocks represents compensation for ownership, while bond payouts are dictated by the “rentier” who seeks both a return on capital and, most importantly, the return of capital. Only government bonds offer the reasonable expectation that capital should always get paid back.

    4
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    Gavekal Research

    5C Overview: The Eminent Case For Rent Control

    The French minister who oversees the housing and construction sectors wants to re-introduce rent controls and toughen oversight of residential building. This enlightened proposal has naturally been met by howls of protest from the industry and most economists. And yet, consider the beneficent consequences that must surely flow from such a measure.

    0
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    Gavekal Research

    Back To MV=PQ

    Inflation expectations may have ticked higher but I am not in the camp that expects rising prices to follow a stronger US economic outlook. In fact a deflationary shock may be on the horizon. Such an outcome, if combined with stronger economic volumes, could be a boon to global economic welfare. But we are walking a very thin line.

    4
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    Gavekal Research

    On US Capital Spending

    There is a common narrative that US companies are “awash with cash.” The puzzle that economists and strategists have been trying to solve in the past few years is why these riches are not being invested. This debate continues today, but the story has moved on. The cash is now gone.

    0
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    Gavekal Research

    A New Widow Maker?

    The Japanese government bond market is famously known as a “widow maker,” since shorting it has crushed so many macro-traders. It looks like the euro is competing to grab title for itself. Many traders have been shorting the currency, with poor results so far.

    2
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    Gavekal Research

    Debate: Inflation Or Bust?

    0
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    Gavekal Research

    A Thatcherite China

    0
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    Gavekal Research

    5C Overview: Panzers At The Border

    I have always been fascinated by those periods when the nomenclature of the day has settled on a risky strategy in the absence of any “plan B”. Think of France’s all-in bet on the Maginot line’s capacity to halt Blitzkrieg, or the fact that Japan’s military elite in WWII had no plan on how to settle for peace—it took the detonation of two atomic bombs for Emperor Hirohito to order his generals to sue for peace.

    0
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    Gavekal Research

    A New Kind Of Trigger Point

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