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    Gavekal Research

    New York Seminar June 2014 - Louis, Anatole & Andrew

    We held our summer seminar in New York on June 10, with Anatole, Louis and Andrew offering their take on the state of the world economy and financial markets. We were also joined by Henrik Christensen who is director of Robotics at Georgia Tech. Audio recordings of their discussions are available below:

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    A Chinese Bretton Woods?

    Even as it plants offshore oil rigs and rams foreign vessels in disputed waters, China is wooing its neighbors with infrastructure investment. Its next step is to create new multilateral banks whose twin goals are to allay fears about Chinese expansionism and to provide an alternative to the US-dominated system of development finance.

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    5C Overview: Volatility RIP

    Having weathered fears of depression, a systemic euroland failure and most recently the specter of deflation, investors can be excused for their insouciant attitude to risk. We may not be in sunlit uplands, but for the first time since 2008 the global growth trajectory looks fairly secure and the big central banks have their monetary policy settings in sync. Hence, it is not surprising that volatility across most asset classes is making new lows...

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    5C Asia: Hop Aboard The Momentum Train

    Far from worrying about policy risks or soft patches in growth, investors suddenly seem to see nothing ahead but clear blue skies—the perfect environment for momentum investing.

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    Overcoming The Macro Breakdown

    The financial crisis of 2008-2009 heralded a golden age for macro investors. As the wholesale market crash rendered the relative value judgments of stock pickers irrelevant, macro investors enjoyed a boom time—especially ones who had had the foresight to short US housing, global financials, or eurozone peripheral debt. Now, as the crisis recedes further into the rear view mirror, macro investors are struggling to adapt to a world in which...

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    Growth & Markets Monthly (June 2014)

    Having watched our growth indicators soften over recent months, we are now witnessing a momentum shift since our economic activity indicators have perked up markedly. Moreover, the velocity of money has risen rapidly, while our price indicators continue to show lessening deflationary pressure. Hence, it was not surprising to see that bonds are getting more expensive. Unfortunately, equities are not cheap, and this makes it a challenging...

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    Gavekal Dragonomics

    CEQ: Investment Abroad — The Dragon Steps Out

    China is now the world's third biggest source of outward direct investment, and the things it is buying are rapidly changing. Gone are the days when Chinese outward investment was all about state-owned enterprises buying oil wells and iron ore mines. There are still plenty of state-driven resource deals, but 40% of Chinese direct investment is now conducted by private firms, who are mainly interested in consumer, technology and service...

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    India’s Interregnum

    Narendra Modi stands as India’s most powerful prime minister in 30 years with a mandate to pursue a pro-economic growth agenda. The reason to stay with the most compelling trade in emerging markets is that a clear reform impulse has been articulated while the capital spending cycle is showing signs of life. The problem for investors is that key choices on fiscal consolidation and specific reform initiatives may not be announced until a budget...

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    Five Corners (28 May 2014)

    In the latest bi-weekly review of global economics and investment:

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    Mean Reversion In Japan

    You did not have to be an investment genius to make a positive call on Japanese equities last year. That was because corporates stood to win from Prime Minister Shinzo Abe’s chosen program, regardless of whether it was successful or not. Enriching Japan’s corporate sector, which has high operating leverage and so is sensitive to any yen depreciation, was effectively a transition phase of Abe’s big plan. The hope was that richer companies would...

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    The Earnings Expectations Paradox

    When it comes to global equity investment, all markets are not equal. Over the last couple of years, investors have evolved distinctly different attitudes about how to discount trends in profit growth in each of the four major equity market regions.

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    Why Thailand Is The Odd Man Out

    In the mid-1990s Thailand’s over-built and excessively geared economy provided a clear early warning signal for the troubles about to engulf the rest of emerging Asia. But having now suffered two military coups in eight years Thailand is less a bellwether than a regional outlier that seems to have given up serious development in favor of a struggle to subdivide existing wealth and power. The good news from Asia is that ascendant political...

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    5C Overview: Keeping China In Check

    How much should we worry about China’s increasing assertiveness beyond its borders? Provocations continue to pile up in maritime Asia, most recently a spat over a Chinese oil rig in what Vietnam considers to be its waters. And last week’s Xi Jinping-Vladimir Putin summit in Shanghai, capped by the signing of a long-delayed US$400 bn gas pipeline deal, conjured the specter of a Sino-Russian concert enabling both countries to defy the United...

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    5C Asia: Less Confidence In A More Confident Bank of Japan

    The message from Haruhiko Kuroda is clear: the Bank of Japan has done enough to reach its 2% inflation target. By extension, we should expect weak yen policies to take a back seat in driving future reflation.

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    How To Lose The Eastern Front

    Russia, it appears, has emerged victorious in Ukraine. After the unofficial referendums organized by pro-Russian groups in Ukraine’s eastern regions, Kiev knows it must negotiate with the separatists to avoid national disintegration. A deal on autonomy for parts of Donetsk and Luhansk will have to be made on terms acceptable to Vladimir Putin.

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    India: Stay Or Go?

    The world’s largest democratic election is all over, bar the shouting, and results will be announced tomorrow. Polls point to a decisive win for the Narendra Modi-led Bharatiya Janata Party which is pro-business and promises a clean sweep of policy. Equity investors have duly jumped on the bandwagon since India is one of the few emerging markets with a decent growth story. But with the market having consistently made new highs over the last...

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    The Case For (Some) Emerging Markets

    Investors in emerging markets need to focus on three main things: nominal GDP growth in US dollar terms, valuations and leverage. The problem is that over the last decade, most EMs enjoyed very strong nominal growth in US dollar terms, in which valuation and currency played a bigger role than real growth. That game has run its course and the key to success in the coming period is identifying those markets with strong real growth prospects that...

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    Five Corners (14 May 2014)

    In the latest bi-weekly review of global economics and investment:

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    EM Carry Trade Looks Vulnerable

    Over the last two months, emerging markets have delivered a handsome rally, with the MSCI emerging markets index recording a 7% return in US dollar terms, compared with just 1% for the developed markets. The trouble is that this rally has been driven primarily by investors’ growing enthusiasm for carry trades in an environment of declining global volatility. Experience teaches this is an engine which can all too suddenly be thrown into reverse

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    Gavekal Research

    After The Repositioning

    After publishing each Quarterly Strategy Chart Book Gavekal partners and analysts book as many client visits as possible, to present the materials and also get fresh ideas for the coming months. And so having just gone around the world to meet investors, we were reminded of Groucho Marx’s words that “I’ve had a perfectly wonderful evening. But this wasn’t it”. Indeed, most of the clients we met with (but especially those who had had a perfectly...

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    5C Asia: Hong Kong’s Diminished Prospects

    Even as Chinese growth has ebbed, Hong Kong has defied the downturn. The territory effectively has full employment and real wages have risen nicely. Over the last year, hot money flows continued to enter Hong Kong and tourists from across the border kept arriving. This, at least, was the case until recently when cracks started to appear in the prosperity of China’s preferred haven for tax-avoidance and luxury shopping.

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    A Supply-Sider’s View Of Japan

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

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    Gavekal Research

    Why Are Bond Yields So Low?

    As long as men continue to age, they will probably complain that “things were better in their day” and that “the world is going to hell in a hand-basket”. Ignore for a moment that the proportion of undernourished people fell from 23% of the developing world in 1990-92 to under 15% in 2010-2012, that more than two billion people gained access to improved sources of drinking water in the past decade, and that never in history have so many people...

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    Growth & Markets Monthly (May 2014)

    For a second straight month, our growth indicators have weakened, suggesting the possibility of another summer lull. The outlier is US employment, as evidenced by last week’s very decent non-farm payroll report. We were also intrigued by the recent pick-up in US 5-year inflation expectations, which does not seem to fit with the narrative of constant deflationary pressures. Combined with recent US wage growth, could this imply that there is a...

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    Five Corners (30 April 2014)

    In the latest bi-weekly review of global economics and investment, Arthur Kroeber considers the implications of Asian deflation. Will Denyer & Tan Kai Xian consider the strong rental market for US homes and wonder what this means for the broader housing sector. Nick Andrews looks up close at reduced liquidity in the eurozone’s financial system. Chen Long looks at a favorable convergence between national GDP numbers and the growth claims made...

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    Gavekal Research

    What Ails The Dollar

    A curious brew of cheap money, a grinding cyclical recovery and “new economy” verisimilitude has helped drive Wall Street to new highs. And yet even as equity investors have scaled the wall of worry, the dollar has remained uninspired. The unit arguably started a structural upswing in 2008 but the recent performance has been lackluster with the DXY index at the bottom of its trading range.

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    Indian Reform: Facts On The Ground

    When Raghuram Rajan took over the reins of India’s central bank last September he faced a weakening economy and persistent capital outflow. His contrarian solution was to jack up interest rates and propose an accelerated internationalization of the long cosseted rupee. This program was not exactly popular, but it seems to have worked. Eight months on India’s foreign exchange reserve buffer is back above US300bn and the currency has strengthened...

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    Gavekal Research

    The Japanese Value Trap

    Equities around the world have enjoyed a modest rebound over the last week, with encouraging signs of buy-on-dips behavior and the leadership rotation that we believe was the main driving force behind early April’s sharp setback (see The New Rotation Into Value). But there is one major market that is a glaring exception to the generalized shift from growth to value: Japan.

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    Gavekal Research

    5C Asia: A Low Beta Korean Won

    The Korean won has defied expectations over recent months by retaining its strength despite last year’s upward spike in emerging market volatility. This resilience confounds traditional perceptions of Korea as a high beta market. Some observers have even argued that the won is now behaving like a classic safe haven currency.

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    Gavekal Research

    5C Overview: How Much More Asian Deflation?

    The latest news from Asia’s biggest economies is uninspiring. China’s growth grinds lower, and the renminbi has declined by 3% against the US dollar since January. Japan is suffering the anticipated effects of this month’s consumption tax hike, and Anatole has predicted that the BoJ will respond later this year with a fresh round of money-printing which could push USD/JPY well above its established level of 102 to the dollar.

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    Gavekal Research

    Five Corners (16 April 2014)

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

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    Gavekal Research

    5C Overview: Why A Balanced Portfolio

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

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    Gavekal Research

    Stay With The JGB Short

    The short JGB trade has a reputation among investors as a widow maker; its devotees live brief unhappy lives and expire early. The prevailing view is that Japan is on the edge of an deflationary abyss. Bank of Japan governor Haruhiko Kuroda appears sanguine for now, but should the economy falter, the market is looking for fresh BoJ support.

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    The Case For Shorting JGBs

    The short JGB trade has a reputation among investors as a widow maker; its devotees live brief unhappy lives and expire early. The prevailing view is that Japan is on the edge of an inflationary abyss. Bank of Japan governor Haruhiko Kuroda appears sanguine for now, but should the economy falter, the market is looking for fresh BoJ support.

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    In Laos, All Roads Lead To China

    Two thousand years ago, in the days of the Roman Empire, it was said that “All roads lead to Rome.” Rome’s might was built on the back of metaled roads constructed by an army of 180,000 legionnaires, who pushed the expansion of the empire to its geographic limits. China’s expansion over its modern-day borders is primarily economic, not military. But as China’s massive domestic road-building program extends over its borders into Southeast and...

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    No Bridgehead Too Far In China’s Expanding Empire

    For centuries, China’s borders expanded and contracted as dynasties rose and fell. With its star in the ascendant, the Chinese empire is expanding once more. This expansion is based on economic power—trade and investment—not military conquest. But it will nevertheless reshape the geopolitics of Asia.

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    London Seminar April 2014 - Anatole, Arthur, Louis & Francois

    We held our spring seminar in London on April 2, with Anatole, Arthur, Louis and Francois offering their take on the state of the world economy and financial markets. Audio recordings of their discussions are available below:

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    Growth & Markets Monthly (April 2014)

    Please find the latest monthly review of our models and indicators. In this edition we note two important changes. First, our growth indicators have taken a turn for the worse, and second our indicators on risk appetite have deteriorated. Since we have seen no significant rises in market spreads, this is probably more a sign of a slightly overextended rally, then a real erosion of financial conditions. Could the rally in risk assets be about to...

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    Gavekal Research

    Bet On Europe Vs The US-EM Axis

    Following decades of European economic integration, euro coins and notes were introduced with great fanfare in January 2002. Equity investors barely noticed as their attention was focused on the emerging trans-Pacific economic relationship between the US and China. Initially, this axis relied on the buying power of the US consumer and the production capabilities of the Chinese factory lands. But as the decade wore on this simplified “ChinAmerica...

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    How To Treat The Fall In Velocity

    Debate continues to rage in our office as to the sustainability of the US economic recovery. On the plus side of the ledger, we can book factors such as decent bank loan growth (both for households and corporates), rising wage growth, falling unemployment and solid business surveys. On the negative side, we find a weakening housing sector (which has been the lynchpin of the US recovery), intensifying disinflationary pressure, and long bond...

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    Will Thailand Ever Smile Again?

    Despite having suffered more than a dozen coups since adopting a constitutional monarchy in 1932, Thailand has largely been a model development story. Annual growth averaged more than 7.5% between 1970 and 1996, and then around 5.5% in the 1998-08 post Asian crisis period. So although the latest political standoff in Bangkok suggests that a deeply divided country is becoming ungovernable, the feeling is also that we’ve been here before—some kind...

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    5C Asia: Cyclical Prospects Favor India Over Indonesia - Udith Sikand & Joyce Poon

    Differences in the way macroeconomic adjustment has affected Brazil, India, Indonesia, South Africa and Turkey have shown that lumping disparate economies together with tags like the “Fragile Five”, “BRICS” or “MINT” does little to illuminate the risk-reward trade-off for EM investors.

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    What Happened To The Asia Beta-Bounce?

    Identifying an Asian upturn or downturn used to be straight forward. One just had to look at cyclical indicators in the developed economies, because Asia would be sure to follow. Yet the bounce in Asian exports promised by recent business surveys in the West has failed to materialize. China, Korea, Indonesia, Thailand—these and other Asian countries have released disappointing trade data so far this year. This is worrisome on a number of levels...

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    One Last Flicker Before The Japan Trade Goes Out

    Most of us at Gavekal have been enthusiastic devotees of Abenomics since late 2012. But Anatole suddenly showed his true Keynesian colors by turning negative on Japan in September, when Prime Minister Shinzo Abe announced his decision to implement a controversial fiscal tightening planned by the Ministry of Finance (MoF) from April 2014. And indeed, the Nikkei has underperformed the S&P 500 by 15% since the consumption tax was announced on...

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    Indonesia's Political Lottery

    If global investors were looking for a reason to go back into Indonesia’s hard-hit market, Joko Widodo has supplied it. The immensely popular governor of Jakarta, who is widely perceived to be a reformer and an efficient administrator, has been confirmed as his party’s nominee in the presidential elections to be held in July this year.

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    The Sword Is The Axis Of History

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

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    5C Asia: Japan - Politics vs Economic Reality

    There is, theoretically, a virtuous cycle of growth embedded in Abenomics. Japanese companies are making more money and are expected to share the wealth through wage increases. This in turn would boost inflation expectations, consumption and aggregate demand. As growth veers away from a dependency on external demand, Japan’s revitalization will become sustainable.

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    Japan’s Self-Defeating Mercantilism

    In the 16 months since Japanese Prime Minister Shinzo Abe launched his bold plan to reflate Japan’s shrinking economy the yen has depreciated by 22% against the dollar, 28% against the euro and 24% against the renminbi. The hope was to stimulate trade and push the current account decisively into the black. Yet the reverse has occurred. Japan’s external position has worsened due to anemic export growth and a spiraling energy import bill: in...

    2
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    Gavekal Dragonomics

    CEQ: China And Japan

    In this issue, we focus on the increasingly tense relationship between China and Japan. Frictions over disputed islands in the East China Sea have stalled bilateral trade and driven the confidence of Japanese businesses in China to the lowest level ever. China's increasing assertiveness, and Japan's election of strongly nationalist leader Shinzo Abe, have sparked worries over a damaging Sino-Japanese conflict. Yet the news is not all...

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    5C Asia: Confession Time For Emerging Markets

    These days we often hear that emerging markets are suffering through no fault of their own. To test this theory we thought we would put on our priest collars and take the confessions of Asian EMs. Charles Gave has long identified five “cardinal sins” that, when committed, inevitably lead to a purgatory on returns for investors. These are protectionism, tax increases, burdensome regulation, monetary policy mistakes and war. Are Asian EMs guilty...

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