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    Gavekal Research

    GaveKal Daily - Poland and the Risks of Fiscal Stimulus

    Like most investors, we keep a wary eye on countries in the twin-deficits club. It is generally believed that once an economy has twin deficits that sum up to 10% or more of GDP, serious trouble is usually around the corner. Unfortunately, some of the world’s most promising economies are slipping towards this category amid the stresses of the past few years. Poland offers an example of how easy it can be to get into this situation, and how...

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    Bad News for Nabucco, Good News for Russia

    Europe’s Nabucco pipeline, a long-planned solution to reduce dependence on Russia for natural gas supplies, appears in peril. The targeted completion for the project, which would make Turkey the gateway to supplies from the Caspian region and the Middle East, has been pushed back until 2017, three years later than originally planned. EU Energy Commissioner Geunther Oettinger last week said delays could mean total construction costs will rise to...

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    Mervyn King as a Contra-Indicator?

    There was a time when central bankers used to pride themselves on their ability to surprise and confuse the markets. These days transparency and predictability are generally viewed as the hallmarks of sound central banking—except at the Bank of England, which seems to believe that confusion and obfuscation are back in style.

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    Northern European Prosperity and the Bund Hedge

    Europe’s strong GDP data published last week have provided a striking illustration of the themes we have outlined since the beginning of last year. They also point to the irony in holding German bonds as a hedge against EMU risk. But let’s look at the facts first:

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    GaveKal Daily - A Challenging Year

    Travelling around the world and meeting investors, we have lately found few happy souls. And to some degree, this makes sense as there have lately been few reliable, bankable trends aside from the weakness in the US$ and the strength in ‘weak US$’ asset plays (oil, mining, HK physical real estate...). However, as the past couple of weeks has shown, jumping on the “weak US$” band-wagon can be fraught with risk as:

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    Mitigating the "Sell in May" Rule

    The ‘Sell in May and Go Away’ rule has a pretty good reputation on equity markets. Its accuracy is usually presented in these terms: on average since year Y, the performance of equity markets from May to September (or October, depending on the version) has been much lower than from November to April. For example, since 1998 the S&P500 declined on average by -1.3% during the May-to-October period, and gained +4.7% during November-to-April....

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    UK Growth & Why Buying Gilts Makes Sense

    While the dollar tumbled this week in response to the US economy’s meagre 1.8% annualised growth rate, the pound was boosted by an almost identical British GDP figure. The bullish reaction in Britain, based on the view that the figure might have been even worse and that the Bank of England would start to tighten regardless in the autumn–seemed even more misguided than overly pessimistic view of the US statistics discussed on today’s Daily. The...

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    GaveKal Daily - Greece, the Ultimatum Game and a Modest Proposal

    Economists love to play games where the rationality of the players can be tested. One such game is called the ultimatum game, in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. If the second player rejects, neither player receives anything. If the second player accepts...

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    An Aging Dividend for Korean Stocks?

    Like many other Asian countries, South Korea faces the demographic challenge of a rising dependency ratio and the peaking of its working-aged population (see chart). The country’s so-called “1958 Year of The Dog Generation”— equivalent to Japan’s “Dankai Generation”, but about 10 years younger as Korean baby boomers were born after the Korean War—will gradually start retiring in the next 10 years. It seems reasonable to expect the Korean economy...

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    GaveKal Daily - A Rising Political Backlash Against EMU Bailouts?

    Since Mrs. Merkel’s promise of ‘unconditional support’ made at Davos earlier this year, systemic risk across Europe appeared to be on the decline (see A Fragmentation of the PIIGS). However, as every investor knows by now, peace in financial Europe has lately been as stable as Middle-Eastern politics—and so, just when the market starts to price in the likelihood of a solution to the European fiscal mess, local politics usually rears its head to...

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    GaveKal Daily - What if Dollar Weakness Isn't Just About the Fed?

    We witnessed an interesting duel of sorts yesterday between two powerful central bankers—the ECB’s Jurgen Stark and the Fed’s William Dudley. Speaking at a dinner event in Hong Kong, Stark dominated the evening by delivering a series of well-aimed blows to the Fed’s monetary philosophy. He pointed out, for example, that “certain developed-world central banks” seem to have failed to abide by lessons learned in the 1970s—namely, that price...

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    Where the Fed Stands on its Mandates

    When Bernanke took the job as Chairman of the Fed, he took on the legal mandate "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." While the desirability of these multiple mandates is debatable, one can see why, in 2008-09, the Fed Chairman felt compelled to aggressively cut rates and buy long-term MBS and UST. Bank loans were contracting, unemployment soaring, CPIs and price...

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    In Europe, What is Priced In?

    I have a number of reservations about Charles’ arguments in his piece, An Old Man's Doubts. But rather than discussing all his points, I will focus on one question only: what is priced in? Charles and Anatole, along with the FT, believe that European markets are complacent about risks. Meanwhile, since the end of last year, I have argued that European markets offer attractive valuation in relation to risks. Indeed:

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    GaveKal Daily - The Implications of Iceland's No Vote

    Eighteen months ago, the gallows humour of bond trading floors was that the only difference between Ireland and Iceland was one letter and about six months. The timing may have proven a little off, and the end result may yet prove very different. However, the questions on the similarities between the two countries may be re-opened by this weekend’s overwhelming “No” vote from Icelandic voters who, for the second time around, have shown little...

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    GaveKal Daily - Is Oil the New Interest Rate?

    With Brent oil at US$122, and other commodities (gold, silver, corn…) making new highs, the single most important question confronting investors is whether oil has become the new interest rate. In a typical cycle, interest rates rise along with economic activity until nominal rates move above nominal GDP growth, triggering a slow-down in growth. However, in this cycle, the dovishness of central banks appears so deeply ingrained that commodity...

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    GaveKal Daily - Is Oil the New Interest Rate?

    With Brent oil at US$122, and other commodities (gold, silver, corn…) making new highs, the single most important question confronting investors is whether oil has become the new interest rate. In a typical cycle, interest rates rise along with economic activity until nominal rates move above nominal GDP growth, triggering a slow-down in growth. However, in this cycle, the dovishness of central banks appears so deeply ingrained that commodity...

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    GaveKal Daily - The Irish Hot Potato

    Last night brought a lot of news from the Euro Crisis front—currently in Ireland.

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    GaveKal Daily - Can Capitalism Work Without a Cost of Capital?

    It is obvious that central banks operate with four policy gauges:

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    GaveKal Daily - The "PIG" Test of the Euro Project

    The European debate continues to rage—including here at GaveKal. Readers of yesterday’s Five Corners page on the weekend’s European Council summit may have noticed that Anatole was unimpressed by the event, which he saw as stronger in rhetoric than action. “What the leaders did was deliver more speeches about their commitment to defend the European financial system,” he wrote. “They then agreed to meet again in another three months’ time to...

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    The Russian Hedge

    The recent events in Japan and the Middle East have considerably changed the situation on world energy markets—in particular for natural gas. First, a sharp decline in gas exports from North African countries needs to be compensated by deliveries of piped gas into Europe by other suppliers; second, the crisis in Japan has led China, Germany and others to re-examine their nuclear strategy, and consider other sources of energy—and here natural gas...

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    The Keynesian Divisor

    If government spending goes up, and if this increase is financed by debt, it is reasonable to believe, as Ricardo did (or Milton Friedman with his constant income hypothesis) that the existing growth rate is borrowed from the future. In other words, it is an illusory growth since government debt is nothing but a deferred tax .

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    Speeches Instead of Safety Nets

    After a tragic plane crash, all the leaders of the European Union are wafted up to Heaven and find themselves in a long queue, snaking off into the distance with no end in sight. After a few minutes, the presidents and prime ministers lose patience and start to grumble, shouting to an attendant angel: “Don’t you know who we are? We are the leadership of the European Union. We demand immediate entry to the VIP lounge.” The angel mumbles something...

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    Running with the Bulls in a World of Extreme Risk

    In the dozens of meetings we have had recently with clients in Europe and the US two messages have come through loud and clear. The first is that we at GaveKal are now worried about the short-term prospects for the world economy and financial markets. The second is that almost all the investors we meet have gone through the opposite transition. After asking repeatedly over the last two years: “is it time to sell this rally?”, we now find almost...

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    The Fragmentation of the PIGS

    One of the interesting similarities between the Eurozone crisis and the subprime crisis is how the contagion risks were initially downplayed. In 2007, Ben Bernanke tried to calm rising fears in the US housing market by estimating that subprime-related losses would hardly surpass a very manageable US$100 billion. Three years later, Jean-Claude Trichet argued that the Greek crisis was not a major issue for the Eurozone since Greece accounted for...

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    GaveKal Daily - Should Investors Buy on Dips?

    As investors think through the crucial question of whether to buy on dips amid the current turmoil, there are not too many comforts or certainties on which to cling. The price of oil is worryingly high and Middle East tensions remain heightened. And while most of the global media coverage from Japan has tended towards the hysteric, there is still a lack of clarity on the radiation threat in Japan and what a potential global “no-nuke” backlash...

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    GaveKal Daily - PIGS Do Well on a Risk-Off Day

    The future of Europe’s monetary union is one that the GaveKal team has debated vociferously (see EMU Debt Crisis, Part III), so it is no surprise that last weekend’s EMU deal was also received with various degrees of emotion. Indeed, our house views are in many ways a microcosm of the broader debate on the Euro. There are those who think this experiment will eventually fail, and good riddance when it does (Charles and Louis); those who think the...

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    Why Diverging EU-US Rates Policy is Dangerous

    There have been plenty of occasions in the past when US and European monetary policy has differed enormously without causing any trouble, so how could the small divergences of monetary policy described on the previous page have had such enormous financial impact? There seem to have been two broad reasons—US currency weakness and German inflation. As shown in the chart below, each of the financial shocks identified (yellow shading) coincided with...

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    Past Clashes in EU-US Monetary Policy

    As Shakespeare said, “when sorrows come, they come not single spies, but in battalions”. Just as the world economy has finally recovered from the 2008 disaster, financial markets are suddenly confronted with three potentially catastrophic and unpredictable risks. The two horrors understandably dominating the headlines are the earthquake in Japan and Libya’s descent into civil war. Both these events, in addition to their human toll, threaten...

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    GaveKal Daily - The Conflicting World of Central Banks

    “There is amongst central bankers a solid unity of purpose to continue to anchor solidly inflation expectations”, Mr. Trichet said yesterday while chairing the Global Economic Meeting in Basel, attended by representatives of most major central banks. But despite these grand proclamations about supposed central bank “unity in purpose”, not everyone is on the same page.

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    GaveKal Daily - Introducing our 2Q Quarterly Strategy Chart Book: A Structural Turning Point for Markets?

    We would first like to offer our readers an apology: it appears that not all clients received the email notification about the publishing of our most recent Quarterly Strategy Chart Book last Friday, due to technical problem with our server. For anyone who missed it, the 2Q Quarterly is available on our website here (at 74 pages, this is a pretty hefty edition so it may take a few minutes to download).

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    QSCB - 2Q11 - A Structural Turning Point for Markets?

    We would first like to offer our readers an apology: not only are we publishing our Quarterly Strategy Chart Book just 24 hours after the publication of our China Economic Quarterly (with can't miss articles on alternative energy, insurance, RMB deregulation, Mongolia, and the property slowdown), but this quarterly is long as well: a full 74 pages!

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    GaveKal Daily - That Didn't Take Long!

    Print Version:

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    A European Tour d’Horizon

    Print Version:

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    GaveKal Daily - Europe's Pass the Parcel Game

    The major trigger for last fall’s blow-out in European spreads was Germany’s rumblings about the need for ‘hair-cuts’ in some cases and Germany’s obvious discomfort at footing the bill to keep the Euro show on the road. In turn, this led to fears that the EMU crisis would spread from the smaller countries to Spain, widely seen as ‘too big to bail’. Still, after much hand-wringing and back-room deals, Germany’s apparent willingness to pay up to...

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    Why Ireland Can Drive a Hard Bargain with the EU

    Friday’s Irish election is the next big challenge for the Euro-zone’s financial stability. There has been very little market comment about the probability that Ireland’s new government will renegotiate the terms of the EU/IMF bailout, even though the Fine Gael-Labour Opposition, who are almost certain to form the next government, have promised to do just that. But if we look at what investors have been doing, as opposed to what they are saying,...

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    A New Mandate For OECD Central Banks?

    Perhaps the most lasting effect of the financial crisis may be on the reputations of central banks. After the resignations of Axel Weber from the ECB and Kevin Warsh from the Fed, came last week’s humiliating gyrations about interest rate policy by the BoE (see Mervyn King’s Capitulation)—which in turn were followed immediately by an attack on the Monetary Policy Committee by one of its own members and an almost unanimous outcry from the British...

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    GaveKal Daily - Global Rebalancing, Inflation and the Value of the RMB

    One crucial issue regarding the lasting power of the current economic recovery is whether growth is on a sustainable trajectory, or being gained through the same ‘old tricks’ that often prove illusory over time. In most of the previous recoveries in the past couple of decades, salvation came through an expansion in the US current account deficit—i.e., the US consumer leveraged up and went on a shopping spree. As we argued in our Quarterly...

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    GaveKal Daily - A New Horizon for Developed Market Tightening?

    We have seen how the world has reacted to increased tightening in the emerging markets—EM has underperformed the developed markets in the past few months. The next question is how will markets react to a faster pace of tightening in the developed markets, which increasingly appears to be on the agenda. Yesterday we had the Bank of England indicate that rate hikes are imminent (see Mervyn King’s Capitulation), and the Riksbank produced its fifth...

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    Mervin King's Capitulation

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    GaveKal Daily - The EMU's Ides of March?

    January saw decidedly improving investor sentiment in Europe, with narrowing PIIGS spreads and a strengthening Euro. However, over the past two weeks, this trend has stalled, with spreads now widening again and the Euro trading lower. This could be related to the impending deadline for the final stability plan. March looms, and in March the EU is expected to reveal details of its final back-stop—whether and when there will be any haircuts,...

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    GaveKal Daily - Shedding Some Light on Turkey's Unorthodox Monetary Policy

    Understanding the real intentions of monetary policymakers has become an even tougher task than usual in these post-crisis times. One example of this can be found in Turkey, where a number of recent monetary actions appear quite contradictory. Despite booming economic growth and worrying global inflationary pressures on food and energy, the Central Bank of the Republic of Turkey (CBRT) has cut its policy rates twice since December. At the same...

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    GaveKal Daily - The Questions Central Bankers Have to Be Debating

    The surprise resignations of Axel Weber from the ECB and Kevin Warsh from the FOMC do leave the outside observer thinking that debates within the halls of these powerful institutions must be rather spirited. As they should following two years of unprecedented activism, even the most unbiased and dispassionate of observers (which we rarely claim to be!) are left with the following quandaries:

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    Is a Greek Sovereign Default Unavoidable?

    As colorfully expressed last year in an essay by Michael Lewis (see Beware of Greeks Bearing Bonds), the idea that Greece can pull off an aggressive fiscal consolidation and economic reform often faces amused rebuttal. Based on the valuation of Greek bonds, the market currently believes that reversing the Greek debt trap will prove to be an impossible mission. Even the already substantial reforms on which Greece has embarked under the thumb of...

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    GaveKal Daily - Strong News and Stronger Markets

    With snow hitting the Super Bowl in Dallas, there is little doubt that we are in the midst of a severe winter. And of course, in winter, bears hibernate. Which is just as well, for bears have little to munch on right now: economic activity is bouncing back strongly, jobs are being created (albeit at a slow pace), global trade is soaring, the great majority of companies are reporting better than expected sales, and US profit margins are making...

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    The Franco-German Compromise

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    The ECB Hikes Rates Without Making Headlines

    Whether Fed and the ECB move together, or apart, matters greatly to forex rates. Bernanke and Trichet both responded to the global crisis by flooding their banking systems with excess reserves, thus driving overnight interbank rates down near their respective ‘floor rates,’ the rate paid by central banks for deposits of excess reserves. With the floor rate set at 0.25% in both systems, the short rate spread thus became negligible. However, one...

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    A Dovish Fed, a Dovish ECB and a Dovish BoE

    Despite the demands for tighter monetary policy now emanating from an unholy alliance of the Chinese Politburo, the Tea Party, the Bundesbank and the Wall Street Journal, last week the Fed and the ECB made clear that early rate hikes are not on their agenda (though Will argues on page five that the ECB may be tighter than it appears). And the Bank of England is likely to send the same message after Thursday’s meeting of the MPC. So why are the...

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    The Hi-Octane Promise of Russia's Market

    The quicker than expected revival of East European growth (see A Four-Pillar Strategy to Investing in Europe) is good news for European companies, who sell much more to emerging EMEA than to China or even to Asia as a whole. And within the emerging EMEA, Russia’s consumer market is the main draw. Even one of Russia’s most protected industries—automobiles—still offers massive potential:

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    GaveKal Daily - A Ricardian Debate on the Back of the UK's Poor GDP Numbers

    Of the many debates currently animating our internal meetings, the most passionate must be the one between Charles and Anatole on whether increases, or cutbacks, in government spending are harmful or helpful for economic recovery.

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    The Rebound in European Velocity

    As the year begins, European financial markets have already rallied much more than most imagined possible. Interestingly, this is occurring while no new concrete decision has been taken by EU leaders on the crisis front. So is the rally a classic case of short covering?

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