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    Gavekal Research

    What Next For Libor Rates?

    The Federal Reserve has not hiked rates this year, but that has not stopped funding cost for US companies and foreign banks from rising. While risk-free rates have barely budged, 3-month LIBOR is up 30bp YTD from 0.6% to 0.9%. This widening of short-term credit spread stems from (i) stress in Europe’s banking sector, and (ii) fund flows ahead of a regulatory overhaul of US “prime” money market funds, which took effect on Friday (see Ripples In...

    3
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    Gavekal Research

    The Strange Case Of The US Trade Deficit

    The last three years saw the US dollar move from being an undervalued currency to an overvalued one, and yet the US trade balance has barely budged. This contrasts sharply with past periods of dollar strength which produced huge US trade deficits that were a boon to global exporters, and also to financial markets which got a liquidity boost. The fear for emerging economies in particular is that this relationship has broken down and a reliable...

    3
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    Gavekal Research

    The Rising Odds Of A US Recession

    We are on recession watch after yesterday’s release of September’s NFIB small business optimism survey. It was not the headline number which got us worried—that ticked down from 94.4 to 94.1. Rather, it was the significant drop in the job openings component—from 30 to 24, or from a cyclical high to the lowest level in 15 months. This suggests that demand for US labor may be rolling over, which is concerning indeed.

    7
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    Gavekal Research

    The World's New Tax Haven

    In the aftermath of the 2008 financial crisis, there was a sense that the systemic failures it revealed would spark a radical overhaul of the global financial architecture. Eight years on, that has not happened: an exception is perhaps offshore finance. The US led the way with its Foreign Account Tax Compliance Act (FATCA), which targets US citizens with footloose money. A more ambitious initiative was launched in 2009 by the G20; it aimed for...

    3
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    Gavekal Research

    Audio & Transcript — Gavekal Research October Call

    Will Denyer presented a newly minted dynamic asset allocation tool which was developed from an ROIC-based framework that has helped us to better map and predict US economic cycles. He then answered listener questions on these themes.

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    Gavekal Research

    Emerging From The Soft Patch

    Three weeks ago we asked whether the uniform weakness in US data—across manufacturing, services and home construction—signaled the start of a recession or merely a summer soft patch. At the time we concluded that what we were seeing was yet another soft patch. Thankfully, the latest round of data releases appears to confirm that conclusion, with the US economy now emerging from its summer doldrums.

    0
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    Gavekal Research

    Angela Merkel’s Catch 22

    Back in April, we pondered whether, with their negative interest rate policies, central bankers were showing themselves to be particularly incompetent by condemning commercial banks to years of unprofitability, or whether their greater design was to drive weaker banks to the wall to advance a consolidation of banking industries around the world under the umbrella of nationalization (see NIRP: Machiavellian Design Or Policy Mistake?). In other...

    5
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    Gavekal Research

    Wicksell's Guide To A Better Portfolio

    With the recent US economic data worryingly soft, and with no convincing drivers of earnings growth to be seen, how should investors position their portfolios? Will and KX set out their methodology for structuring a dynamic Wicksellian portfolio to generate superior returns at reduced levels of volatility, and determine the optimum allocation mix for the current troubled environment.

    7
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    Gavekal Research

    Singapore Seminar—September 2016

    Audio and video from the latest Gavekal seminar in Singapore is available here. Louis Gave explains why financial markets have recently behaved predictably, and why that is about to change. Andrew Batson explains why Chinese policy making is in a holding pattern until next year's party congress is settled. Udith Sikand explains why this year's emerging market outperformance is likely to continue, as bonds and especially equities have...

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    Gavekal Research

    Will Low Volatility Get Trumped?

    As we enter the final stretch of the exhausting US electoral cycle, the single most important question confronting investors may well be whether the current low volatility environment for equities, bonds, and exchange rates is dependent on politicians or not. Clearly, with the VIX hovering around 12, and with volatility in exchange rates barely noticeable (see Forget Central Banks, Watch Foreign Exchange Volatility), financial market...

    0
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    Gavekal Research

    Debate: A Trump Win And The Dollar

    As the world seriously tunes into the US presidential election, four Gavekal partners debate the outlook for the US dollar should Donald Trump emerge victorious and set about his promised remaking of the international security order and global trading system.

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    Gavekal Research

    Don’t Count On US Profits Riding To The Rescue

    A funny thing happened to US equities once the dust cleared after the late June sell-off that was sparked by the UK’s Brexit vote. As yields of most income earning assets fell on hopes of yet more central bank easing, equity investors discarded growth concerns and engineered a multiple expansion which drove the market to new vertigo-inducing highs (see Real Yields In The Driving Seat). The big question now is whether a profits boost can keep the...

    1
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    Gavekal Research

    Knowing Whether To Buy The Dip

    With all the current focus on the Federal Reserve and markets, it’s easy to overlook the increasingly ugly state of the underlying US economy. Throughout the long post-2009 recovery, when any one driver of US growth showed signs of stalling, the others continued ticking over nicely, which meant overall growth averaged out around 2%. Recent data releases signal that has now changed. Although none of our key indicators has shown a dramatic...

    4
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    Gavekal Research

    Watch Real Yields On Corporates

    There are increases in real rates, and there are increases in real rates. And by no means are they all equal in impact. In Tuesday’s Daily, Joyce and KX noted that global equity markets have been supported this year primarily by the world-wide decline in real bond yields. After bond markets approached over-bought territory over the summer, the sharp increase in real yields we have seen over the last couple of weeks naturally hit stock prices. If...

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    Gavekal Research

    The End Of A Bubble?

    Ask three economists for the definition of a financial bubble, and you will be lucky to get fewer than four different answers. Even in our little shop, we like to make distinctions between bubbles in productive assets (US railroads, the internet, fiber optic cables, shale gas wells...) and bubbles in unproductive assets (gold, tulips, Japanese land, Florida condos…). We also like to make distinctions on how bubbles are financed: equity (good) or...

    2
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    Gavekal Research

    Post-Impeachment Brazil: Not For Beginners

    When it finally came, Dilma Rousseff’s ouster by impeachment on August 31 was, in the harsh language of markets, all in the price. The question for investors, who may have (profitably) ridden the rumor of her demise since January, is whether they should now sell the fact. A reason to stick with the trade is that after a severe recession, Brazil’s economy is stabilizing. Confidence levels have perked up and 2Q16 saw industrial output and...

    0
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    Gavekal Research

    Real Yields In The Driving Seat

    Notwithstanding yesterday’s bounce, the stock market is a nervous place just now. After riding a post-Brexit rebound that saw both the S&P 500 and the Nasdaq Composite scale record highs on minimal volatility, investors are increasingly wondering about the extent of the potential near term downside, not just in the US but around the world

    2
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    Gavekal Research

    Prepare For Hurricanes

    After months of contented lethargy, Friday’s big sell-off seemed to confirm the main points that Louis and I made in our conference call two days earlier. Firstly, the faith in “lower forever” bond yields is not a reason for reassurance, but a cause for concern. Secondly, political risks have not been eliminated by the summer’s market rally, merely ignored. Thirdly, what I call the “financial hurricane season” usually starts in early autumn—and...

    8
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    Gavekal Research

    The New Ineptocracy

    In times past, capitalist systems were organized on a simple premise. At the centre sat “money” as the medium to express all values. The primary operating dynamic of this system was that surplus money (savings) got channelled into economic activity, with a secondary effect that “unused”, or “left over”, money ended up in financial assets, usually equities, such that at times of great optimism a bull market resulted. After running for a year or...

    7
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    Gavekal Research

    Gavekal Research Monthly Conference Call — September 2016

    In the inaugural Gavekal Research monthly conference call, Louis, Anatole and Arthur addressed the global growth environment and offered asset allocation suggestions.

    0
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    Gavekal Research

    A Better G-20 Communiqué

    Another year, another G-20, another yawn. Though the group of the world’s 20 biggest economies was useful in the aftermath of the 2008 financial crisis, it has since degenerated into another global drawing room where leaders explain to one other how the world would be a better place if only it were a better place. This was a missed opportunity.

    1
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    Gavekal Research

    I Must Admit That I’m Confused

    Friday saw the release of US jobs market data for August which had investors convinced of a continued “not too hot, not too cold” outlook for the world’s largest economy. This is at odds with the view that I have held for a while; namely, that the US has been on the brink of recession or may have even entered one. This prognosis was based on a hopefully not insubstantial analytical foundation, which may be worth reviewing.

    3
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    Gavekal Research

    The Return Of US Fiscal Policy

    More than three years after the world fretted about the US economy falling off a “fiscal cliff”, there is suddenly much talk of government spending being used to gin up growth. Whatever their many differences, both Hillary Clinton and Donald Trump favour a fiscal expansion, with a focus on upgrading the US’s aging infrastructure stock. At the same time Federal Reserve officials, led by Janet Yellen and John Williams, are arguing for more fiscal...

    3
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    Gavekal Research

    The Fed’s Hawkish Stance

    For those who thought Janet Yellen a dyed-in-the-wool dove, her Jackson Hole speech on Friday gave pause as she endorsed fellow policymakers’ recent statements that the US economy was strong enough to warrant interest rate rises. Markets quickly adjusted. The implication for global asset markets is not altogether encouraging.

    0
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    Gavekal Research

    Video: Yield Chasing—What Could Go Wrong?

    Louis outlines his view on this summer's unusual global economy and offers investment advice going forward into autumn.

    0
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    Gavekal Research

    The Falling Natural Rate Is No Mystery

    As the high priests of global central banking congregate in Jackson Hole, much of the chatter ahead of the meeting has concentrated on the “mystifying” fall over recent years in the natural rate of interest, and possible reasons why it should have declined to such an extent. Having spent the last ten years attempting to apply the economic theories of the great 19th century Swedish economist Knut Wicksell, I have to say I am delighted with the...

    6
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    Gavekal Research

    The Next EM Yield Play?

    With global growth having stabilized and central banks remaining in super-easy mode, the dash for yield is making emerging markets ever more interesting. In recent months a number of our Hong Kong-based writers have advised investors to play this trend through bonds not equities, with Udith chiming in on Monday (see Indonesia: Bet On Stability Not Growth). The question for those who expect this “not too hot, not too cold” phase to persist is...

    7
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    Gavekal Research

    A Brexit-Induced Recantation

    Exactly two months have now passed since the Brexit referendum. It is now an appropriate time to review what has happened, and what hasn’t, since June 23. As a quintessential member of the elite that was angrily repudiated by a majority of British voters, this referendum was a profound emotional trauma. Therefore, my initial reaction turned out to be completely wrong.

    10
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    Gavekal Research

    Cheap For A Reason

    By most measures, US equities are not cheap. Yet many investors remain overweight, believing that in a world of ultra-low interest rates and negative bond yields, equity valuations should be higher because future cash flows are now discounted at a much lower rate than in the past. At first glance, the equity risk premium—the expected return on stocks over and above the risk-free rate—appears to support this belief. At more than one standard...

    0
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    Gavekal Research

    The Dollar And The Next Crisis

    For a third straight month in June, foreigners unloaded US bonds, with “official institutions” leading the way on net sales of US$33.5bn versus a small rise in buying by offshore private investors. The interesting thing is that foreign central banks have been lightening their US dollar reserves for a while, but the contraction has now intensified to -5.6% year-on-year. Previously, such a decline in foreign holdings of the global reserve currency...

    7
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    Gavekal Research

    Ripples In The Eurodollar Market

    The Eurodollar market is making waves. While most benchmark interest rates around the world have been stable or softening, US dollar Libor has bucked the trend. Over the last seven weeks three-month Libor has climbed by almost 20bp to a shade over 0.8%. Meanwhile the TED spread, which effectively measures interbank credit risk by tracking the spread between Eurodollar rates and three-month US Treasury bill yields, has shot to its widest since...

    2
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    Gavekal Research

    Irving Fisher, Debt-Deflation And The Bifurcated US Economy

    Many of our readers will be familiar with Irving Fisher’s great 1933 paper The Debt-Deflation Theory Of Great Depressions. The main point of this fascinating work is that if an economy suffers simultaneously from over-indebtedness and falling prices, then strange things start to happen. These include a fall in the velocity of money and a collapse in capital spending. And when it comes to interest rates, Fisher explained that things get really...

    3
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    Gavekal Research

    The Last Free Lunch In US Markets

    Even as US equities hit new highs, this most policy-driven of bull markets remains unloved, with most investors we meet expecting an eventual collapse. US profits are declining, valuations are rich and the headwinds facing the industrial sector, in particular, show no sign of abating. On an economy-wide basis, the return on invested capital earned by US firms is falling, so edging the economy closer to recession (see A New Look At Capital:...

    1
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    Gavekal Research

    Beware The “High Dividend” Lure

    Investors have been piling into US high dividend plays as they offer decent income and a “margin of safety” in an increasingly expensive equity market that, despite soft earnings, continues to make new highs. The chase for yield has been boosted by global central banks’ easing measures which have helped drive bond yields to pifflingly low levels; at the same time the S&P 1500 dividend yield has stayed steady this year at about 2%. Yet any...

    0
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    Gavekal Research

    The Caveat In US Payrolls

    Notions of a US growth scare were apparently banished on Friday with a bullish payroll report for July helping drive US equities to a new high and causing the dollar to rally strongly. Some 255,000 jobs were added—far better than the expected 185,000—while a cycle-high average hourly earnings gain of 2.6% YoY points to strong domestic demand. So how to square this data with the far less cheery 2Q16 GDP report, released last week, which showed...

    2
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    Video: Risks In US High Dividend Stocks

    0
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    Gavekal Research

    The Baleful Influence of Inventories

    The reason US second quarter GDP growth was so disappointing at 1.2% QoQ annualized was a deep contraction in US business inventories, which knocked -1.16pp off the quarterly growth figure. In itself, a fall in inventories need not be such a bad thing for longer term growth. If inventories get run down because companies are unable to keep up with a surge in demand, then a fall in inventories can foreshadow increased investment to expand business...

    0
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    Gavekal Research

    Recession Or Stagnation?

    On Friday US GDP data for 2Q16 was released showing an expansion that looks ever more anemic and unconvincing. Is this just the new normal in an era of stagnant global growth or is the US more perilously poised? To answer that question, imagine the US economy having two parts in the shape of “consumer GDP”, which represents about three quarters of activity, and the remainder being the non-consumer “production” portion.

    3
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    Gavekal Research

    There’s No Need To Fear A Tighter Fed

    While the US Federal Reserve left interest rates unchanged yesterday as expected, it did revise its statement to sound marginally more hawkish. Most notably, it added the line, “Near-term risks to the economic outlook have diminished,” while tweaking its language to reflect recent relatively solid data releases. The market took the announcement in its stride. The S&P 500 ended the day little changed. Yields on 10-year treasuries fell...

    7
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    Gavekal Research

    The EM Equity Question

    Despite this year’s strong run-up, there remain good reasons to stick with emerging market assets. The twin impact of collapsed borrowing costs amid a renewed global hunt for yield, and greatly reduced exchange rate volatility has been the ideal environment for EM yield curve flattening trades.

    2
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    Gavekal Research

    Trump And The Prisoner’s Dilemma

    Let us assume that Mervyn King is right and the week-to-week strategy of major central banks has become to stop equity markets within their jurisdiction from going down. And let us further assume that markets are fully convinced of central bankers’ resolve to achieve this end. In the case of US equities, which sit at the center of the global system, such a proposition logically means that their price has two components: (i) the “intrinsic value...

    1
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    Gavekal Research

    The Flow Through To EM Equities

    These are strange times for investors with bond yields in big developed markets plumbing new depths on dark concerns about never ending deflation and stagnation. Yet in a clearly related development, US equities are making new highs while corporate- and emerging market-bonds continue to rally.

    2
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    Gavekal Research

    US REITs And The Rush For Yield

    One of the side effects of negative interest rates and central bank asset purchases in the eurozone and Japan has been a reach for yield which has seen foreign investors rush into relatively high-yielding US assets, compressing yields and spreads to an extent that appears at odds with the late-cycle stage of the US economy. Earlier this month the 10-year US treasury yield set a new low of 1.36%, while US Baa-rated corporate bond yields fell to...

    2
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    Gavekal Research

    Tools, Jewels And P/E Ratios

    There are two basic reasons why an asset has value and this understanding should be foundational knowledge for anyone running a portfolio. They can be prized for their efficiency (a tool) or desired because of their scarcity (a jewel). Investors preferences for jewels versus tools will shift through time, but what does not change is the fact that scarcity cannot lead to economic growth.

    0
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    Gavekal Research

    The Post-Brexit Rally: Head Fake Or Game-Changer?

    Let’s face it, few expected the rally in global risk assets of the past ten days. Even investors who, like Charles, believed that Brexit was a fundamentally positive development did not expect positivity to erupt quite so suddenly. Yet, here we are, with the Nikkei up 10% since its post-Brexit low, the S&P 500 breaking out to new highs and the Shanghai benchmark above 3,000. Will it last?

    3
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    Gavekal Research

    The Consumer Alone Can’t Avert A US Recession

    With a strong US job market auguring well for income growth, and healthy household balance sheets, many believe the growth of consumer demand will outweigh dismal exports and weakening capital spending, staving off recession. But close inspection of historical data shows the US can tip into recession even though consumption remains broadly stable.

    2
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    Gavekal Research

    A Fundamental Assault On Freedom

    Of all basic freedoms, one of the most fundamental of all is the freedom of the individual to organize his or her relationship with time. The way we order our affairs with respect to the all too brief time allocated to us on this earth is a profound right that we all should be allowed to exercise unhindered. In short, everyone should be free to choose whether to be an ant or a grasshopper.

    10
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    Gavekal Research

    Politics Trumps Jobs

    So, it was a false alarm. By that I do not mean the Brexit vote, which remains, for reasons explained at the end of this note, the biggest threat to the world economy and to risk assets since the global financial crisis. The false alarm was the brief panic about a US recession caused by the slump in employment growth reported last month. As I said at the time there were four possible explanations for the shockingly weak May payrolls (see...

    0
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    Gavekal Research

    US Bonds As A Hedge: It’s Complicated

    F. Scott Fitzgerald noted that the test of a first rate intellect was being able to hold two opposing ideas, yet still function. The same could be said of any investor who aspires to follow a rules-based portfolio management strategy. Inevitably, such rigor occasionally requires messy compromises with reality as is now the case in the US bond market. Such is my dilemma as I try to broadly follow three rules:

    2
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    Gavekal Research

    US Auto Sales: Shifting Down A Gear

    At first sight it was worrying last week when June’s number for US automobile sales came in at a disappointing 16.7mn annualized, well below the street’s expectations of 17.3mn. Auto sales are closely followed as a leading indicator of both US consumption growth and the overall business cycle, so at this stage in the cycle, when consumption is the only remaining driver of US economic growth, the undershoot was especially troubling. Worse,...

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