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    Gavekal Research

    Is The China Panic Abating?

    For the past six weeks, global markets have been in a China-centric panic, sparked partly by bad economic data, but mostly by policy bungling from China’s policymakers. Having spurred a huge expansion in equity margin debt, regulators turned tail in June and cracked down on the practice. As an equity market crash unfolded, policymakers took to swinging a big stick: price-keeping operations were tried, stock trading was halted and speculators...

    5
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    Gavekal Research

    The Fed’s Opportunity For Lift Off

    There are many problems in the world today, but too-high a cost of capital is not among them. This is not going to change if the Federal Reserve hikes short rates by a quarter of a percent this week, or in December. We have no particular insight as to when the Fed will make its move, but there are good reasons for it pull back on the “lift off” lever before the end of the year. Recent ructions in global markets are not likely to deter Janet...

    6
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    Gavekal Research

    Has The Fed Missed The Boat?

    It is decision week at the Federal Reserve. At its meeting this Wednesday and Thursday, the Federal Open Market Committee must decide whether the US labor market has now tightened enough to warrant the first interest rate increase since mid-2006, even though inflation is subdued and financial market sentiment remains fragile following the summer’s bout of heightened volatility. It is an unenviable decision—all the more so since the recent...

    0
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    Gavekal Research

    I Know, I Know...

    ...the US economy is doing fine and after the longest run up in history, may be on the verge of achieving take-off velocity. So why am I so worried? The problem is that my US recession indicator has entered negative territory, after literally collapsing in the last 6 months. Today I will try and explain my concerns about the US, when all others seem fixated by China. It should be acknowledged that since about 2002 the US economy has been managed...

    3
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    Gavekal Research

    Is The Bull Market Over? (II)

    Yesterday we examined the three big fears that—in the absence of any markedly negative news from the OECD economies—lie behind the recent equity market sell-off, and which have prompted many investors to ask “Is The Bull Market Over?”

    2
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    Gavekal Research

    Is The Bull Market Over? (I)

    Is the bull market in equities over? As our readers might imagine, this is a question we have been asked more than once over the past few weeks. Notwithstanding the bounce of the last two days, the simple fact that clients are wondering about the answer is troubling in itself. Their doubts are embodied by three ominous developments:

    1
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    Gavekal Research

    The US Current Account Deficit And World Markets

    Spotting turning points in the US current account is central to Gavekal’s research method, as such shifts impact all other economic relationships. When the US dollar is strong the US tends to run a big current account deficit, providing the world with lots of “earned dollars.” Conversely, a weak dollar eventually leads to a shrunken US current account deficit and more incentive to borrow in dollars. Big moves in the dollar exchange rate create...

    0
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    Gavekal Research

    Termaillage And The Renminbi

    For years I have felt like a lone voice in the wilderness, monitoring central bank reserves as an important determining factor of what I loosely call “international liquidity”. Suddenly I’ve got company. In the last few weeks everyone has been focusing on the topic, and “experts” by the dozen have penned reports about it. Naturally, I’ve read everything that has passed across my screen, and—sad to say—I’m appalled by the results: an egregious...

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    Gavekal Research

    What To Do With US Bonds

    Given the recent turmoil in financial markets and an intensifying focus on the Federal Reserve’s forthcoming policy decision, it seems a good time to update readers on our thinking about the proper positioning of a US fixed income portfolio. As a starting point, it is worth restating the two main determining factors that influence the yields on longer-dated treasuries.

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    Gavekal Research

    The Four Horsemen Of The Apocalypse

    Markets are entering bear market territory and what vexes Charles and Louis is whether the root cause is a liquidity crunch, a solvency crisis or a deflationary bust. In this wide ranging chart book they explore the problem through the revelatory prophecy of four riders whose presence marked the coming of judgement day. We don’t mean to pile on the misery in what is shaping up as a tough week and the moderately good news is that the-end-of-times...

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    Gavekal Research

    The World Monetary Base And The Dollar

    If the supply of US dollars is declining then, all else being equal, the value of the dollar should rise, and vice versa. This truism can be checked by comparing the annual growth rate of the “world monetary base” with changes in the JP Morgan trade weighted dollar. Regular readers will recall that the WMB is simply the sum of the US monetary base and foreign exchange reserves deposited at the Federal Reserve for the account of foreign central...

    12
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    Gavekal Research

    Portfolio Construction Towards The End Of The Cycle

    Buy into the rebound or position for the real sell-off still to come? It is a tough question at this point. Most investors are confident we are considerably more than half way through the cycle, but they are far from certain the end is nigh (especially after yesterday’s big upward revision of US GDP). For the bamboozled, the summer sell-off of 1998 offers some interesting parallels.

    4
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    Gavekal Research

    The Real Message From Oil

    Violent swings in oil prices are destabilizing economies and financial markets worldwide. When the oil price halved last year, from US$110 to US$55 a barrel, the cause was obvious: Saudi Arabia’s decision to increase its share of the global oil market by expanding production. But what accounts for the further plunge in oil prices in the last few weeks—to lows last seen in the immediate aftermath of the 2008 global financial crisis—and how will...

    18
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    Gavekal Research

    A Solvency Crisis Or A Liquidity Crisis?

    Over the past five years, critics of zero-interest rate policies have typically fallen into one of two camps:

    0
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    Gavekal Research

    The Four Horsemen Of The Apocalypse

    In almost every good movie battle scene, the heroes must face attacks on several fronts at once. Invariably, as losses mount, the defensive perimeter shrinks until, with American movies at least, (Saving Private Ryan, Fury…) the cavalry arrives in the nick of time, and our heroes are saved. If the movie is French (La 317eme Section) the position gets overrun and, like in Camerone or Dien Bien Phu, a glorious disaster ensues. Right now, many...

    1
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    Gavekal Research

    How To Build A Reserve Currency

    A store of value, a unit of account and a medium of exchange—these are the three essential characteristics of any proper currency. Needless to say a reserve currency must possess all three. But they are far from enough. A reserve currency must have at least six other attributes too, as Jacques Rueff and Robert Triffin did so much to establish.

    1
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    Gavekal Research

    The Bright Spot In The US Market

    Even though US home prices have risen by more than a third in the last three years, the residential construction sector has been a persistent disappointment, showing little meaningful recovery. That is finally changing. On Monday the National Association of Homebuilders’ Housing Market Index hit its highest level since 2006, while July data released yesterday showed housing starts closing in on an eight-year high at an annualized 1.2mn rate....

    0
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    Gavekal Research

    What About The Dollar?

    Often as not the crucial signal offered by markets is what, at a particular juncture, they did not do. This is especially the case when events unfold, that, on the face of it, add credence to a consensus view. With this in mind consider a few key market developments from last week.

    0
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    Gavekal Research

    Strong US Data Confirm Underweight

    Data released on Friday reaffirmed the robust health of the US domestic sector. Paradoxically, this only strengthened our conviction that investors should underweight US equities in favor of other markets.

    0
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    Gavekal Research

    Long Live US Productivity Growth!

    The contrast between last Friday’s strong US employment report and the very pedestrian GDP figures published three days earlier draws renewed attention to the greatest paradox of the post-2008 economic recovery. GDP growth since 2008 has indicated the weakest cyclical expansion on record, but employment growth has been roughly as strong as usual, at least in the US and Britain. Post-crisis US employment has grown fairly steadily at a rate of 1.5...

    2
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    Gavekal Research

    Stop Worrying And Learn To Love Cheap Oil

    In almost every financial cycle there comes a point when the publicly expressed views of analysts and investors diverge completely from market behavior. Occasionally this can be what George Soros has called a moment of truth, when investors suddenly realize that a financial boom has wildly overshot economic fundamentals and is about to turn to bust. But often it turns out that the markets have grasped a message that has not yet been consciously...

    5
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    Gavekal Research

    Tech As A Commodity

    Technology equities have been a solid performer in the post-2008 crisis era, which is perhaps not surprising as the sector tends to do best in periods of innovation-fueled “creative destruction” and strong deflationary forces. Yet with the tech sub-index having outperformed the S&P 500 by more than 15% over the last two years, there are clear indications that this phase may have played out. Not only are the cyclical drivers ebbing, but the...

    0
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    Gavekal Research

    Growth & Markets Monthly (August 2015) – by Pierre Gave

    Our latest monthly indicators look to have taken on a somewhat schizophrenic character. On the growth side, our main indicator of global economic activity is perking up, implying a stronger second half of the year. But our diffusion index of OECD leading indicators is clearly heading south, as are commodities. A similarly bifurcated story can be seen on the risk-appetite side. Our velocity indicator has registered improvement and short term...

    1
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    Gavekal Research

    More Cautious Than Ever On US Stocks

    Exactly six months ago, we declared we were Turning Cautious On US Equities. At the time we noted that while US domestic demand was healthy, US stocks no longer looked cheap, the US dollar was no longer competitively valued, and the Federal Reserve was moving unambiguously towards tightening monetary policy. Half a year later, the S&P 500 has risen 4.3% and the Nasdaq Composite 9.2%. On the face of it those look like respectable returns; not...

    1
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    Gavekal Research

    Who Killed US Productivity Growth?

    Four and a half years ago, in February 2011, I published one of my first pieces of Wicksellian research, entitled The High Cost Of Free Money. In it I wrote that negative real interest rates were going to cause a sustained decline in the productivity growth of US labor, which in turn would lead to a deterioration in the structural growth rate of the economy. In making these observations, I was merely following the logic of 19th century Swedish...

    7
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    Gavekal Research

    Three Ugly Charts

    I would never claim to be an accomplished technical analyst, but I do know how to use a ruler when looking at charts of prices in the markets.

    5
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    Gavekal Research

    Five Corners (July 29): The Slowdown In Trade

    Overview: After years in which the world’s major governments have been busy manipulating prices, Charles Gave finds it astonishing that anyone should be surprised by the current slowdown in global trade.

    0
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    Gavekal Research

    Three Risk Factors For US Growth

    In the run-up to the meeting this week of the rate-setting Federal Open Market Committee and the release on Thursday of second quarter gross domestic product data, confidence in the strength of US economic activity is deteriorating. It is not just that most market participants now expect 2Q growth to be modest relative to last year, with the consensus looking for an annualized QoQ figure of 2.7% compared with 4.6% for 2Q14 (see Not Déjà Vu Again...

    0
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    Gavekal Research

    5C United States: Who Gains From The Widening US Trade Deficit?

    After four years of US dollar real effective exchange rate appreciation, the US trade deficit is finally showing signs of widening. Both exports and imports have slumped heavily in value terms, largely because of a combination of weak oil prices and US dollar strength. Trade volumes paint a clearer picture, with exports down -0.5% year-on-year in May, while imports rose by 3.5%. As a result, the US trade deficit has expanded from 2.5% of GDP in...

    0
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    Gavekal Research

    5C Overview: Why The Surprise At Slowing Trade?

    I am afraid I am rapidly turning into Gavekal’s resident bear—asleep half the time, grumpy the rest. In particular, I am amazed how some people have suddenly discovered that world trade is going nowhere, and that they are so bamboozled by this strange pattern. Where exactly have they been for the last 15 years?

    0
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    Gavekal Research

    The Signal In Silver (Part II)

    Last year I came up with a chart (shown below) that I found rather intriguing. It showed that on every occasion in the last 100 years when the price of silver dropped more than 25% year-on-year, consumer price inflation in the US took a nose-dive soon afterwards.

    5
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    Gavekal Research

    The Typology Of A Deflationary Bust

    In the summer of 1998 I wrote the first report for a new venture that was eventually to become Gavekal Research. It was called The Typology Of A Deflationary Boom. My contention at the time was that the US was in a deflationary boom and in the report I tried to explain to the tiny handful of readers we then had how to manage money in such a period. Booms and busts tend to be byproducts of the interest rate policies followed by central banks. The...

    18
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    Gavekal Research

    What Price US Growth Stocks?

    Ever since US equities bottomed in March 2009, glamour stocks such as Google, Amazon and Netflix have been at the forefront of the rebound, leading the Nasdaq composite to an all time high this week. While we continue to prefer other markets over the US (see Turning Cautious On US Equities), recent moves in mega-cap US growth stocks have set us wondering how long the outperformance of growth stocks over value stocks can last. After all, even...

    3
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    Gavekal Research

    Black Days In Brazil, But No Black Swan

    The end is not yet in sight for Brazil’s dreadful recession. The seasonally-adjusted economic activity index was down –3% YoY in June, and the current consensus forecast for full-year GDP growth is –1.7%, against +0.5% in January. Continued tightening of monetary and fiscal policy, coupled with lackluster external demand, makes possible a second year of economic contraction in 2016. The Brazilian real has lost -16.5% against the dollar this year...

    0
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    Gavekal Research

    Five Corners (July 15): Deflation Redux

    Overview: When governments interfere with the price discovery mechanism, most people believe the inevitable result is runaway inflation. On the contrary, argues Charles Gave, official manipulation of prices threatens to plunge us all into deflation. United States: Tan Kai Xian examines the marked divergence between goods prices and services prices and ponders what it means for the overall US inflation outlook. Europe: As the eurozone inches its...

    0
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    Gavekal Research

    5C United States: The Divergence In Inflation Rates

    Following last year’s collapse in oil prices, US inflation declined from 2.1% in May 2014 to zero in May this year. Close followers of the US economy will know, however, that this zero rate masks a sharp bifurcation in prices. The slowdown in headline inflation has been propelled entirely by goods prices, which slumped -9.6% YoY in May thanks to modest international price pressures and the strong US dollar. In contrast, services prices, which...

    0
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    Gavekal Research

    The Purpose Of The Stock Market

    When you’ve been around for as long as I have, you can’t help but come to a few conclusions—most of them unhappy. My first conclusion is that the stock market was invented to make as many people as possible as miserable as possible for as much of the time as possible. In this sense the stock market is a roaring success.

    5
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    Gavekal Research

    Growth & Markets Monthly (July 2015)

    With the drama in Athens casting a pall over markets, what is the message from the Gavekal dashboard of economic and risk indicators? Overall, reasonably positive. Our main growth indicator suggests that the momentum of economic activity should pick up in the second half of the year. If correct, this would mark a repeat of the pattern seen in the last few years. Still, given the uncertainty associated with the Greek situation, there has been a...

    0
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    Gavekal Research

    US Payrolls Are Running Out Of Juice

    Later today we will publish our Growth & Markets Monthly, updating Gavekal’s dashboard of essential economic and risk indicators. The markets side of the equation is relatively straightforward this month: although investors have not switched into full risk-off mode, with the outlook for Greece’s eurozone membership as uncertain as ever ahead of this weekend’s referendum, there has been a clear diminution in their appetite for risk. What of...

    0
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    Gavekal Research

    Five Corners (July 01): Manufacturing Machinations

    Overview: Charles Gave argues that the manufacturing sector remains the last bastion of proper economic data in the US, and the message being sent is not good. United States: Tan Kai Xian somewhat demurs from Charles and argues that the US manufacturing sector is unlikely to be the fountainhead of the next US recession. Europe: Central Europe has emerged as the manufacturing powerhouse of Europe at the expense of France and the southern...

    0
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    Gavekal Research

    5C Overview: Manufacturing And Recessions

    I know that metal bashing and the business of making things comprises a declining part of economic activity in most industrialized economies. Yet as economist Brian Reading used to say in the 1980s, GDP may be getting lighter, but manufacturing continues to have a heavy influence.

    0
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    Gavekal Research

    5C United States: Will Weak Manufacturing Derail Growth?

    Marching into the second half of 2015, the US economy is gradually recovering after another weak start to the year. The majority of forecasters are now expecting a rebound in the US second quarter gross domestic product growth. This makes sense as domestic demand remains strong, supported by lower oil prices, a strong job market and deleveraged household balance sheets. However, while we have seen a robust rebound in most economic data series,...

    0
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    Gavekal Research

    Don’t Fret (Yet) About US Housing

    In the summer of 2013, a sharp rise in US bond yields driven by the taper tantrum derailed the US housing market. Will the upward spike in 10-year treasury yields from 1.7% in February to 2.4% today do the same? So far, the market is showing no signs of fear. Despite a 40bp increase in mortgage rates, monthly housing sales and prices remain highly encouraging, as do the weekly numbers for mortgage applications. Meanwhile, US homebuilder stocks...

    2
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    Gavekal Research

    Gauging The Chances Of A US Recession

    A successful investment strategy requires an early warning system to monitor risks in key markets. Right now, I am most worried about a possible recession in the global system’s most important economy, namely the United States. Any evidence of an impending US recession will surely spark a collapse in investor confidence as it becomes clear that central bankers are not, in fact, the omnipotent creatures of their billing. I am especially...

    1
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    Gavekal Research

    The Fed And Dollar Depreciation

    So no surprises. A slightly more dovish Federal Open Market Committee stuck to the script of future monetary policy moves being data dependent. Since the US central bank yesterday scaled back its 2015 GDP growth forecast to 1.8%-2%, the implication is that rate increases, even if they start in September, will be a gradual affair. Investors liked what they heard as this suggests that Goldilocks lives, and a “not-too-hot, not-too-cold” scenario...

    0
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    Gavekal Research

    Five Corners (June 17): Bond Market Shakeout

    Overview: Charles Gave argues that the lack of market-making capacity in the financial sector means that the next big market move could be highly disorderly. United States: 10-year Treasuries look overvalued on a fundamental basis, but don’t expect an immediate correction says Tan Kai Xian. Europe: German bond yields have had a roller coaster ride of late so François Chauchat checks in to reassess their valuation anchors. China: From a standing...

    0
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    Gavekal Research

    Switch In Favor Of US Multinationals

    In recent weeks the US dollar has grown increasingly sensitive to changes in expectations for US interest rate hikes, with the currency’s DXY index fluctuating daily in response to every shift in sentiment about the precise timing of the US Federal Reserve’s first upward move. But while the exact date of the lift-off is crucial to the short term trajectory of the foreign exchange market, over the longer run the US dollar’s upside looks limited.

    4
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    Gavekal Research

    5C Overview: Efficiency, Capital And Bond Market Spreads

    In the “good old days” much of the capital deployed in financial markets was devoted to making markets work better. Until the mid-1980s investment banks were often partnerships whose capital was directly owned by the partners. On occasions when a disorderly market emerged that capital was “put to work”, sometimes for just a few minutes—profitability was very high. Such capital was often “owned” by a family such as the Rothschilds, Barings or...

    0
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    Gavekal Research

    5C United States: Treasury Yield Normalization

    The trigger for the recent jump in 10-year treasury yields from 1.9% to 2.4% was leveraged investors unwinding long positions on European government bonds. This is not surprising as a “deflating” eurozone was a key reason for last year’s decline in global bond yields. Today, the outlook has improved as the single currency area looks to be enjoying a modest recovery. Absent a Greek-inspired contagion, Europe is likely to be less of a factor...

    0
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    Gavekal Research

    Oil At Its Ceiling, Not Floor

    With oil prices rebounding strongly this week, despite the non-event of last Friday’s meeting of the Organization Of Petroleum Exporting Countries, it seems appropriate to re-examine the case for cheaper oil that we have been presenting since late last year. Specifically, our view in December that US$50/bbl was more likely to be a ceiling than a floor for the Brent oil price in the long term has been contradicted by market actions of recent...

    2
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    Gavekal Research

    Protect And Survive

    Bond yields keep rising, emerging markets are softening and key cyclical stocks have taken a bath. The more I look at the global situation the more I am convinced that both economies and markets are reaching a point of transition. And as that old sage Yogi Berra said: “When you come to a fork in the road, take it!”

    3
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    Gavekal Research

    To Cheer Or Fear US Wage Growth?

    Is the US equity market merely taking a breather before the next upward leg of the bull run? Or has it reached a worrying plateau, marking US stocks out for a protracted period of underperformance? With domestic profit margins facing a squeeze between the strong US dollar on one hand, and stirrings of wage growth on the other, we are worried it is the latter. As we argued on Tuesday, the US dollar’s strength means that any rewards US firms...

    4
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    Gavekal Research

    Will The Buyback Craze Ever End?

    Scientists tell us one of the things that sets us humans apart from other mammals is our relatively large prefrontal cortex, the part of our brain that allows us to resist the lure of instant gratification and instead sacrifice ephemeral pleasures for solid long term gains.

    6
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    Gavekal Research

    The Spat In The Spratlys

    It is typhoon season once again in the South China Sea. Last May, China ignited a storm of violent protest across Vietnam when it started drilling for oil off the Vietnamese coast. This year the squall is further south in the disputed waters of the Spratly Islands, where the US has demanded that China halt its land reclamation efforts. Ordered to leave the area by the Chinese military last week, a US Navy surveillance aircraft ignored the...

    0
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    Gavekal Research

    Five Corners (3 June): Shifting Capital Flows

    Overview: Louis Gave traces China’s rejection of planned economy shibboleths over the last 30 years and contends that Beijing is charging full tilt toward the final frontier: the liberalization of capital itself. United States: With the strength of the US dollar favoring imports over US-made goods, the US current account balance is set to deteriorate. This, argues Will Denyer and Tan Kai Xian, will mean a bigger supply of US dollar liquidity in...

    0
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    Gavekal Research

    Not Déjà Vu Again For The US

    With the mid-point of 2015 approaching it looks to be a case of “déjà vu again” for a US economy suffering early year blues. As with other “soft patch” periods, there are plausible explanations for this stodginess that don’t just involve beating up on statisticians for their seasonal adjustment techniques. The US indeed had a cold winter and the West Coast port strike disrupted trade flows. But the real question for investors is whether the US...

    1
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    Gavekal Research

    Growth & Markets Monthly (June 2015)

    This month saw a clear deterioration of our growth indicators. The pattern of the last few years with a weaker than expected first half of the year appears to be holding up. The question is whether 2015 will see the habitual pick-up in the second half of the year? On the inflation front, things remain quiet. US breakeven inflation rates, which looked as if they may have been breaking upwards last month, are now heading south again. Given the...

    0
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    Gavekal Research

    5C United States: The Rising Supply Of 'Earned' US Dollars

    The US dollar is the world’s reserve currency, which means the US can settle its current account deficit by issuing more US dollars. As Charles says, this means any contraction in the US current account deficit means fewer US dollars flowing abroad (see The US Current Account And Vanishing Global Liquidity). Naturally the reverse is also true. Following the strengthening of the trade-weighted US dollar index over the past four years, the...

    1
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    Gavekal Research

    A Question Of When, Not If

    The cacophony emanating from China can be disorientating. On the one hand, China’s domestic stock markets are in the throes of a vigorous bull run. Locally-listed equities are up 140% in the last 12 months, with repeated government support measures and rising openness to international fund flows sustaining the momentum. On the other hand, China’s economic growth continues to slow, while the geopolitical drumbeat is increasingly daunting. With...

    0
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    Gavekal Research

    Towards A US Recession?

    Yesterday the Federal Reserve minutes showed policymakers to be nervous about the outlook for US growth, and so more likely to extend the zero interest rate policy. I would, of course, argue that this is to confuse cause and effect, as US economic weakness in fact stems directly from ZIRP (see The Untimely Demise Of US Productivity). But what concerns me today is less whether a quarter point rise in policy rates happens next month or in...

    10
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    Gavekal Research

    Five Corners (20 May): Assessing Oil's Comeback

    Overview: In light of the rebound in oil prices Anatole Kaletsky questions his own view that the oil market is becoming driven by “marginal cost producers”, rather than classic monopoly dynamics.

    0
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    Gavekal Research

    What Could Spur US Equities

    A common bias for investors is to assume that relationships between the market and economy in one phase must persist in the next. For example, since 2009 US firms have mostly grown profits by expanding margins—i.e. cost-cutting. Hence, the logic runs that if wages start to rise, profit margins must fall, leading to weak profit growth, and hence lower equity prices. Implicit in this logic is an assumption that margins must drive profits. There is...

    4
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    Gavekal Research

    The Untimely Demise Of US Productivity

    Let’s start with a statement of fact: since 2002 the growth of US productivity, measured as non-farm output per hour worked, has collapsed. Outside of recession periods, this is the first time since the 1950s that the four-year moving average of the annual rate of change in productivity has fallen so low. This matters because without a rise in productivity, the US economy will struggle to boost its citizens’ standard of living, whether measured...

    3
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    Gavekal Research

    The Dissonance In Markets

    Perhaps the biggest challenge confronting investors today is the disconnect between financial markets and economic data. Indeed, despite weak readings from the growth locomotives of the global economy (China and the US), recent weeks have seen bonds selling off, commodities going on a tear, and deep cyclical equities experiencing huge rebounds. In short, while economic data is pointing towards a mediocre global growth outlook, markets are...

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    5C United States: Why So Calm After The Oil Price Collapse?

    After oil prices halved, profits in the sector look to have followed suit—S&P 500 energy firms in 1Q15 saw an eye watering -55% YoY plunge in earnings. Given this backdrop, it was to be expected that gory tales would emerge from the oil fields of Texas and North Dakota of bankruptcies, mass layoffs, forced sales and shotgun marriages. To be sure the oilfield services space has seen a bit of this, but generally an eerie calm prevails.

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    5C Overview: Regime Change In The Oil Market Only Just Starting

    Since late last year, when the battle for oil market share broke out between OPEC and the US frackers, we have argued that this is not just a contest between rival groups of producers, but between distinct pricing regimes, based on very different economic principles (see Will US$50 Be Oil’s Floor, Or Its Ceiling? and The Macro Dividend From Oil).

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    Gavekal Research

    Bull Market, What Bull Market?

    Underweighting US equities has become a consensual position and yet the market continues to flirt with new highs. So what gives? My approach has always been to rely on decision rules built on historical data analysis. When enough of these rules signal a “buy” or “sell”, I make a move (for a good example of this approach see Managing Equities In A Strong Dollar World). My esteemed colleague Anatole has been arguing for a while that the S&P500...

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    Gavekal Research

    New York Seminar May 2015 - Anatole, Louis, Joyce & Will

    We held our US spring seminar in New York on May 11, with Anatole, Louis, Joyce & Will offering their views on the most important developments in the global economy.

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    Gavekal Research

    When Bond Markets Become Silly

    Investors are understandably spooked by recent bond market ructions given a backdrop of weakening growth in major economies, and continued accommodative central bank policy. Francois argued yesterday that this “tantrum” was partly technical, but also the result of markets looking through to higher inflation expectations due to an apparently better economic outlook (see Tantrum II And European Portfolios). I agree with him that markets are being...

    2
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    Gavekal Research

    Why Brazil Trumps India

    The last year has been tough for emerging market investors—a recent survey showed that only 20% of actively managed EM funds beat their benchmark compared to an average 60-70% over the past five years. Recent weeks have not provided much respite with out-of-favor, commodity-rich markets like Russia and Brazil going on a tear, while much loved darlings such as India have taken a pounding.

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    Gavekal Research

    More Tantrum Than Crash

    Nothing lasts forever, not even bond market bubbles operating under the tutelage of ultra-dovish central banks. Despite the promise of limitless financial repression in the eurozone and Japan, bond-buyers look to be going on strike. Long-dated US yields have crept higher over the last month, while yesterday’s market action saw investors throw in the towel on the eurozone’s peripheral bond markets. We even got the odd sight of the Australian...

    1
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    Gavekal Research

    Five Corners (6 May): The Weakness In Wages

    Overview: Charles Gave wonders why in spite of policymakers having the best of intentions, their efforts have caused declining productivity, lower median incomes and fewer quality jobs. United States: The labor market is no longer a clear indicator of the US economic cycle, says Will Denyer, who looks for new insights into what variables may guide the Fed in its policymaking. Europe: Although jobless numbers have fallen across much of the...

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    Gavekal Research

    Growth & Markets Monthly (May 2015)

    While our growth readings ticked higher last month, the big shift came with a sharp rise in our risk appetite indicators. We also note an easing of deflationary pressure with the US breakeven inflation level registering a nine-month high. On the liquidity side, the European Central Bank has cranked up its expansionary efforts and its balance sheet is rising at 16% YoY. Taken together, these moves have benefited equity markets (notwithstanding...

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    Gavekal Research

    5C Overview: The Real Message From Labor

    So how are we to understand the less than thrilling message emanating from the labor markets of the main economies. Is this evidence of some unescapable “secular stagnation”, or is something else going on?

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    Gavekal Research

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

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

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    Gavekal Research

    Beware Of Crowds, And False Prices

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

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    Gavekal Research

    Whither US Manufacturing

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

    3
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    Gavekal Research

    No One Likes To Pay Taxes

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

    2
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    Gavekal Research

    A Post-Volatility World

    These are words that I utter with the utmost caution—this time, it really is different. I refer not to central bankers’ scurrilous efforts at monetary debasement, nor the spineless diplomacy of European political leaders, or even the cult of celebrity in the age of social media. In some guise, we have seen all of this before. No, dear reader, for something genuinely new to the modern experience, consider the right hand side of the chart below...

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    Gavekal Research

    Five Corners (22 April): Global Trade

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

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    Gavekal Research

    Drop The Dollar Hedge

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

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    Gavekal Research

    5C United States: Competitiveness Lost

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

    0
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    Gavekal Research

    5C Overview: Why The Coming Collapse Of World Trade Should Be Celebrated

    Sustained economic growth has always gone hand-in-hand with a big rise in communications infrastructure. To explain why, assume that a country has two cities, named A and B. At the point that a modern communication infrastructure is built (road, trains, internet) then, in each case, a single line of communication is needed. Three cities implies the need for three lines; a fourth city means six lines. Ultimately, if all the cities are to...

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

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

    0
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    Gavekal Research

    The US Market’s Silver Lining

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

    0
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    Gavekal Research

    Three Brothers In Arms: Wicksell, Schumpeter And Fisher

    I am often asked which of the great economists best understood the link between the economy and financial markets. Passing judgment on such giants may be presumptuous, but practical men and women of finance may want to consider being slaves to the following propagators of ideas:

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    Gavekal Research

    One Belt, One Road, One Grand Strategy

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

    2
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    The Darkest Hour Before Euro Dawn

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

    5
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    Gavekal Research

    5C US: Doing More With A Flatter Yield Curve

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

    0
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    Gavekal Research

    Exogenous vs Endogenous Shocks

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

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    Gavekal Research

    The Divergence In Market Action

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

    3
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    Gavekal Research

    The Fed’s New Policy: Zero Real Rates

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

    2
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    Gavekal Research

    Five Corners (25 March): Where To Find Value

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

    0
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    Gavekal Research

    All 21st Century Roads Lead To...

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

    0
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    Gavekal Research

    Trying To Measure The US Dollar Short Position

    It seems to be conventional wisdom that the long-dollar trade has become worryingly “crowded”. That was certainly the message after last week’s none too startling language tweak by the Federal Reserve produced a frantic dash out of the unit. But as ever, there is what you see, and what you don’t. In this case, what is obscured may be of far greater significance than what is visible in plain sight. Here is why:

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    Gavekal Research

    5C Overview: Three Regions, Three Strategies

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

    0
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    Gavekal Research

    5C North America: Northern Exposure

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

    0
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    London Seminar March 2015 - Anatole, François, Andrew & Charles

    We held our main spring seminar in London on March 17 with Anatole, François, Andrew and Charles offering their views of the global economic pulse and recent market and central bank developments.

    0
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    Gavekal Research

    Asia Is Not So Scary

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

    1
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    Who Gains When The Fed Hikes?

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

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