Wednesday, September 30, 2009

Bill Gross' bet on "the New Normal"

Bill Gross is buying long-term government treasuries and he expects slower growth and low interest rate in coming years (source: Bloomberg).

Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., said he's been buying longer maturity Treasuries in recent weeks as protection against deflation.

"There has been significant flattening on the long end of the curve," Gross said in an interview from Newport Beach, California, with Bloomberg Radio. "This reflects the re- emergence of deflationary fears. The U.S. is at the center of de-levering as opposed to accelerating growth."

Gross had said during the midst of the credit crunch that Treasuries offered little value as investors seeking a refuge from turmoil in global financial markets drove yields to record lows in December. He boosted the $177.5 billion Total Return Fund's investment in government-related bonds to 44 percent of assets, the most since August 2004, from 25 percent in July, according data released earlier this month on Pimco's Web site. The fund cut mortgage debt to 38 percent from 47 percent.

"We've exchanged our mortgages for the government's check" as the Federal Reserve winds down purchases of agency debt, Gross said today. "Mortgages are expensive compared to Treasuries and other vehicles."

Fed policy makers last week committed to complete their $1.45 trillion in purchases of mortgage securities and extended the end of the program to March from December.

Policy Reversal

Pimco's Total Return Fund handed investors a 17.85 percent gain in the past year, beating 94 percent of its peers, according to data compiled by Bloomberg. The one-month return is 1.94 percent, outpacing 57 percent of its competitors. Pimco is a unit of Munich-based insurer Allianz SE.

Pimco in July reversed a policy to steer clear of U.S. debt when it said it would buy five- to 10-year Treasury securities.

"With Treasury yields near the top of our expected range, Pimco plans to overweight duration and take exposure to the five- to 10-year portion of the yield curve," the firm said July 20 in a report on its Web site.

On that day, the yield on the 10-year note touched an intra-day high of 3.72 percent and a low of 3.57 percent. The note yielded 3.29 percent at 10:36 a.m. today in New York.

Gross said intermediate- to long-term bonds will perform well as long as policy rates and inflation remain low, after minutes of the Federal Open Market Committee's Aug. 11-12 meeting was released on Sept. 2.

'New Normal'

Officials at Pimco have forecast a "new normal" in the global economy that will include heightened government regulation, lower consumption and slower growth. The economy will likely expand at a 2 percent to 3 percent rate going forward, Gross said.

The world's largest economy shrank at a 1.2 percent annual rate from April to June, more than the originally reported 1 percent contraction, according to a Bloomberg News survey before the Commerce Department's Sept. 30 report. The jobless rate climbed to 9.8 percent this month, from 9.7 percent in August, according to a separate Bloomberg survey before the Labor Department reports figures on Oct. 2.

Tuesday, September 29, 2009

Michael Mussa: US economy will have a sharp rebound

Michael Mussa is a no-nonsense economist. It's always good to hear him.

Mussa offers some insights of why he thinks US economy will have a rapid recovery. He expects annual growth rate to be 4.5% and accumulative growth rate from now to the end of 2010 to be 6.8%, both substantially higher than the blue-chip forecast.

Mussa's forecast largely based on the observation that the sharper the economy falls, the steeper the economy will come back. This statistical behavior of business cycle is shown in the following graph and also documented in my previous post.

Mussa's forecast still left many questions unanswered: Should we simply rely on a historical statistical pattern to make our economic forecast? We know every recession is different; What if this Great Recession is so different that it will break this historical pattern.

Now I give you Michael Mussa (Source: PIIE, about 30 mins)

Rank 2009 market rally

Following my last post that looks at the current market rally in historical perspective, here is another update from FT.

Just admit it: most institutional managers simply missed the rally since March. Now in order to keep their jobs or get higher compensation, they have every incentive to get into the market even when the market is already overpriced.

This is one of the main reasons why we had bubbles in the first place: investment managers compete for portfolio performance with their peers --- as long as the party is on, they will have to keep dancing.

I am afraid we are likely to head into another asset bubble.

(click to watch; source: FT)

The future of China's exchange rate policy

Nicholas Lardy and Morris Goldstein, of Peterson Institute of International Economics, talk about the evolution of China's exchange rate policy and the future.

Starts to watch from 3'30".

Monday, September 28, 2009

Bet on precious metals

Source: WSJ

While gold is grabbing the headlines, its sister precious metals are actually reaping the most gains. For the year to date, platinum and palladium, two lesser-known metals, have surged 38% and 56%, respectively, far eclipsing gold's 12% gain. Silver is up 42% over the same period.

[platinum prices]

With their dual roles as precious and industrial metals, platinum and palladium are managing to profit from both sides of the debate over whether an economic recovery is on the horizon.

Platinum and palladium have a multitude of uses, with the auto industry taking about 60% of each metal's annual production for catalysts to reduce tailpipe emissions. Some bulls view the metals as a bet on economic recovery, and on the struggling automobile sector in particular.

Meanwhile, for those concerned about the fragility of economic conditions and the Federal Reserve's printing of money, some see the metals as a store of value like gold.

However, despite "cash for clunkers" programs around the world boosting vehicle sales, analysts still think auto makers' demand for both metals will decrease this year. Even with output likely to decline because vital South African mines are plagued with power shortages and labor disputes, both the platinum and palladium markets still confront the threat of a surplus.

[platinum market] 

One factor supporting prices is the growing appetite from exchange-traded funds that are backed by platinum and palladium. As investors speculate on commodities, the total amount of the metals held by six such funds -- traded in the U.K., Switzerland and Australia -- hit records last week, with about $1 billion in assets, according to Barclays Capital.

Of late, China may also have helped prop up the metals, with imports of platinum and palladium up 92% and 63%, respectively, in August from a year earlier, fueled by stronger demand from jewelers and auto makers.

Last year, Chinese jewelers and auto makers accounted for 16% of platinum's global consumption, according to metal refiner Johnson Matthey. China's jewelry demand for platinum is this year projected to exceed peak purchases seen in 2002, meaning a jump of 43% from last year, according to John Reade, a UBS metals strategist. However, real demand growth isn't strong enough to support such explosive imports, suggesting stockpiling.

With car makers in Detroit and elsewhere still facing weak sales, the rally in platinum and palladium seems to have gotten ahead of itself. Without the support of a sustainable rebound in industrial demand, prices could wane once stockpiling slows down. Any loss of faith in the strength of the expected global recovery would likely hurt the two metals a lot more than gold.

Sunday, September 27, 2009

Why China must do more to rebalance its economy

Martin Wolf writes on FT that rebalancing its investment-skewed economy is in China's own interest.


China has had a good crisis. That became obvious at the "summer Davos" of the World Economic Forum, in Dalian, less than two weeks ago. Chinese confidence was palpable. But so was anxiety. The giant has survived the shock. But its recovery is driven by a surge in credit and fixed investment. In the longer term, China needs to rebalance its economy, by increasing consumption. It is time for the Chinese to enjoy themselves more. How unpleasant can that be?

The man who best captured both the confidence and the uncertainty was premier Wen Jiabao. He told the meeting that "the unprecedented global financial crisis has taken a heavy toll on the Chinese economy. Yet we have risen up to challenges and dealt with the difficulties with full confidence". But he also admitted that the "stabilisation and recovery of the Chinese economy are not yet steady, solid and balanced".

The data coming out of China suggest a powerful recovery is indeed under way. In the first half of the year, noted the premier, gross domestic product expanded 7.1 per cent. The September consensus forecasts suggest that the Chinese economy will expand 8.3 per cent in 2009 and 9.4 per cent in 2010. The Asian giant is expected to become the world's second largest economy in 2010, even at market prices.

According to the Economist Intelligence Unit, domestic demand may expand by as much as 11.5 per cent in real terms this year. Such a surge in Chinese internal demand is exactly what was needed. Chinese household consumption is also forecast to grow 9.3 per cent (see chart). Yet, as usual, real fixed investment is the locomotive. It is forecast to grow 14.8 per cent this year. If so, it would have grown faster than GDP in all but one of the past 10 years. This rising ratio of investment to GDP, from an already high level, is not a strength but a weakness. It suggests declining returns on capital. It risks creating ever-rising excess capacity. Moreover, when growth rates finally fall, the collapse in investment is going to knock a huge hole in demand.

The heavy reliance on investment is not the only risk ahead. So, too, is the surge in credit and money (see chart). Many believe this is bound to lead to another upswing in bad debt and destabilising asset bubbles. The jump in the ratio of broad money to GDP is also worrying, coming after a long period of stability.

China, it appears, has saved itself. Has it also been saving the world?

The most encouraging development is the shrinkage of China's current account and trade surpluses (see chart). Both exports and imports have fallen sharply, but exports have fallen further. Yet China's trade has been so volatile (along with everybody else's) that it is hard to be sure this will prove a turning point. Much will depend on the nature and pace of the global recovery. Moreover, the country will continue to run a substantial current account surplus and accumulate still more foreign currency reserves, even though they are already far larger than China needs for insurance purposes. After all, they reached $2,132bn (over 40 per cent of GDP) in June of this year.

That would be equivalent to official holdings by the US government of $6,000bn (€4,000bn, £3,670bn) all denominated in the currencies of other countries. It is little wonder such a huge exposure makes the Chinese government nervous. But nobody asked the Chinese to do this. On the contrary, US policymakers have consistently (and wisely) advised them to do the opposite. Having made what I believe was a huge mistake, the Chinese government cannot expect anybody to save them from its consequences.

A substantial appreciation of the Chinese currency is inevitable and desirable in the years ahead. The longer the Chinese authorities fight it, the bigger their losses (and the pain of adjustment) are going to be. What they have to do is cut those losses, by ceasing to accumulate yet more reserves. As Morris Goldstein and Nicholas Lardy of the Peterson Institute for International Economics argue, in an excellent recent study, the policies required to do this are also needed to help rebalance the economy in the long term.

It is important to understand how distorted China's economy now is: in 2007, personal consumption was just 35 per cent of GDP. Meanwhile, China was investing 11 per cent of GDP in low-yielding foreign assets, via its current account surplus. Remember how poor hundreds of millions of Chinese still are. Then consider that the net transfer of resources abroad was equal to a third of personal consumption.

This is surely indefensible. The premier may even agree. In Dalian, Mr Wen remarked that "we should focus on restructuring the economy, and make greater effort to enhance the role of domestic demand, especially final consumption, in spurring growth". An appreciation of the real exchange rate, ideally via a rise in the nominal exchange rate, would help. Not the least of the distortions of the current regime is the need to keep interest rates low, to curb capital inflows. This shifts massive amounts of income from households into corporate profits.

Whether China's partners will raise the issue of exchange rate policy in Pittsburgh, at the summit of the G20, is, alas, unclear. The Chinese are probably powerful enough to prevent it. But President Hu Jintao will surely complain about US protectionism. I sympathise with him. I would sympathise far more, however, if China's foreign currency interventions, combined with the sterilisation of their natural monetary effects, was not such a massive subsidy to its exports.

The big point for China is that, like it or not – and it is perfectly clear to even the casual visitor that many Chinese dislike it intensely – the explosive rise in trade and current account surpluses of the mid-2000s is an unrepeatable event.

The short-term rebalancing of this year, via a huge credit expansion and surge in fixed investment, is a temporary expedient. It must lead to a rebalancing of the Chinese economy towards consumption. This is in China's interests. It is also in the interests of a better balanced world economy. If the successful response of this year leads in this direction, the crisis will have brought great long-term benefit.

"A crisis," as they like to say in Washington these days, "is a terrible thing to waste." They may be ungrammatical. But they are right – and not only for the US.

Saturday, September 26, 2009

Julian Robertson: We put ourselves into this terrible position...

Julian Robertson, former hedge fund manager of Tiger Management, shares his insights about the future of the US economy. He repeated this many times, "Our leadership failed and put ourselves into this terrible position that if Chinese and Japanese don't buy our bonds anymore, we are doomed...inflation could easily go up to 15-20%."

The excess had been building up over the years and reached to such a unsustainable level (see the graph below); It's hard to imagine how the US economy could get back on track without a serious sacrifice from the US consumers.

The efforts of government and the Fed to prop up the economy through printing money and more government debt are just trying to stop the pain for a short while. It's delusional to think we will get over this and get back to party again.

Watch this interview from CNBC:

One thing Robertson didn't mention is: If Chinese stop buying US bonds, where can they put their money? At least I don't see China has that figured out. Not yet.

Peter Schiff: Gold could hit $5,000

I am not as bold as Peter in predicting Gold price, but I think there is a good chance that gold price will go even higher than today, either because we will have a surge in consumer price inflation when the economy snaps back quickly, or we'll have an asset bubble, most likely in all kinds of commodities, even when the economy still remains slack. The latter is a more likely scenario.

Friday, September 25, 2009

China's Volvo bid

Boosted by Goldman Sach's $250 million investment, China's little known auto company, Geely, is trying to swallow the premiere brand, Volvo. China badly needs Volvo's technology to develop its 21st centry cars. Ford tries to prevent such technology transfer/leak and nurturing a potential rival in the future. But Ford is cash-strapped and Volvo brought Ford over $1 billion loss in recent years. World is fast changing. Reports WSJ.

Chinese auto maker Geely Holding Group Co. has emerged as the leading contender to acquire Swedish automaker Volvo from Ford Motor Co., said several people familiar with the matter.

Ford is in the process of analyzing a recent Geely bid to acquire 100% of Volvo for approximately $2.5 billion, these people said. The offer is higher than Ford or outsiders had expected for a brand that has lost more than $1 billion in recent years. In the quarter ended June 30, Volvo lost $231 million.

The deal may nonetheless be worth far less to Ford, given Geely's proposal to leave behind Volvo pension obligations, unwanted inventory and other substantial restructuring liabilities with Ford, said these people. Such a deal would be similar to Ford's sale of luxury brands Jaguar and Land Rover to India's Tata Motors Ltd. in early 2008. Tata paid $2.3 billion for the two brands. Ford then later contributed $600 million to Tata to cover Jaguar-Land Rover pension plans.

Geely and other Chinese firms want Volvo for its strong brand name and technology. Its dealer network also represents a chance to penetrate the U.S. and European markets with non-Volvo product. Geely has been especially emboldened of late, after its Hong Kong-listed company, Geely Auto, just received a $245 million investment from Goldman Sachs Group's private-equity arm.

Geely declined comment.

Volvo's technology is becoming a critical feature of the negotiations, say the people familiar with the matter. Volvo has jointly developed collision warning systems, passenger-restraint technology and other safety equipment used by Ford and its other brands. Ford fears it could be handing over that technology to a company that is expected to become a direct competitor in Europe and North America. Ford officials continue to mull whether the technology "could bleed all over the place," said one person familiar with the negotiations.

Another sticking point has been a preference by Geely and other Chinese automakers to acquire only a portion of Volvo, while Ford has been adamant it wants to part with 100% of the unit. Originally Geely hoped that Ford would retain at least a 25% stake in Volvo, but Ford has declined to budge, according to a person briefed on the matter. The other remaining bidder is China's Shanghai Automotive Industry Corp., also known as SAIC Motor.

One challenge for Ford: Pulling Volvo out of its operations, having deeply integrated the two since Volvo's purchase for $6.4 billion in 1999.

Through August, Volvo sold 42,013 vehicles in the U.S., long considered its most important market. That's down almost 25% percent from the same period in 2008. For all of 2008, Volvo sold 73,102 vehicles in the U.S.

Ford put Volvo on the block last December, with J.P. Morgan Chase & Co. handling the sale. "We expected this to be a pretty long process because of the environment we're working in," Ford Chief Financial Officer Lewis Booth said in an interview this month. "We haven't got an explicit timetable. We're still talking to interested parties. We're working through the options."

Once Volvo is sold it will complete the dismantling of Ford's expensive and failed Premier Automotive Strategy.

Thursday, September 24, 2009

What is "global rebalancing" about?

I hope it's not about trade protectionism. Listen to this thoughtful discussion from On Point, out of NPR of Boston.

Creative destruction in auto industry

This financial crisis and severe recession bought down two US auto companies: Chrysler was taken over by Fiat; GM is still under government restructuring plan.

This is not necessarily a bad thing.

As you will see from the videos below, when the high wall of auto lobbying finally came down, and new innovative companies got their day, consumers will end up with better vehicles.

How about a pollution-free sports car?

What is needed now is mass demand that can quickly push down the cost of production. Every new innovation will encounter high fixed cost. The question is how to make it more affordable. Government subsidy might be a good solution in this case if the initial demand is hard to sustain.

Tuesday, September 22, 2009

Michael Pettis on China

Michael Pettis, former investment banker, now professor at Peking University in China, talks about his view on China-US trade relations, China's growth model and possibility of China diversifying away from the US dollar.

If you don't know who Michael Pettis is, read my previous post on him.

(click on the graph for the video; source: FT)

Economic recovery is under way

Equity market may be overpriced, and is due for a correction in the near term. But the big-picture direction for the economy is on the way up.  This trend is very clear if you look at the Conference Board's Leading Economic Indicator, LEI. 

LEI and GDP growth are highly correlated, with correlation ratio near 80%.

Sunday, September 20, 2009

Lessons from 'the lost decade'

Source: WSJ

Much of the financial news this month has revolved around the one-year anniversary of the Panic of 2008 -- the collapse of Lehman Brothers, the takeover of Merrill Lynch, the government's bailout of Wall Street.

But there's another anniversary for investors. It is 10 years this weekend since the publication of "Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market," a popular seller that became the poster child of 1990s stock-market hubris.

Authors James K. Glassman and Kevin A. Hassett weren't quite the Dan Browns of their day, but in their book they nonetheless claimed to have discovered a virtual secret code buried within the stock market.

[Dusan Petricic]
In a nutshell, they argued that, even in that period of wildly "irrational exuberance," shares were massively undervalued. Their reading of history revealed that shares were far less risky over time than was widely assumed. As a result, they concluded that the Dow Jones Industrial Average, which at the time stood at 10300 or so, was really worth more than three times as much.

It's easy to mock that brash forecast now. But few were laughing at the time. On the contrary, although only some on Wall Street were willing to take the arguments to these ridiculous extremes, many shared their underlying assumptions.

Back then, the only people subject to sustained derision on Wall Street were those who dissented. Anyone who warned that shares might disappoint was ignored. The few predicting a crash -- let alone two -- were considered cranks. (For the record: The Dow, which continues to enjoy a remarkable post-crash rally, rose another 2.2% last week; it's up 50% since March. But it's still below where it stood in September 1999.)
Beyond a sorry contemplation of the past 10 years, what does this anniversary offer investors? What have we learned from the last decade? And where do we go from here?

Here are seven lessons of a lost decade:

1 Don't forget dividends. In the 1990s bubble, investors figured they were going to make all their money on capital gains. That's a reason they were willing to buy shares paying out little or nothing.

Reality: Dividends have been investors' life raft since. The Dow has fallen about 7% since the book came out. But when you include reinvested dividends, investors in the market are about even over that period.

2 Watch out for inflation. Price increases have been modest in the past decade, but during that period the dollar has still lost about 23% of its purchasing power.

So investors in the market have really gone backward. Ignoring inflation is a mistake too many are making again now as they keep all their money in bank accounts paying little or nothing. What matters isn't just your nominal or headline return. It's your return -- after inflation.

3 Don't overestimate long-term stock-market returns. It's remarkable to replay all those foolish, over-optimistic assumptions you used to hear everywhere about the stock market -- "Wall Street goes up by around 8% to 10% a year," "shares will earn 7% above inflation over the long term" and so on.
What's the truth? A global study conducted a few years ago by the London Business School suggested the average long-term return may have only been about 5% over inflation, rather than 7% or more.

That may not sound like a big difference, but over time it's huge. It cuts your likely profits by a third over a single decade. And it means you run a much bigger risk that you will lose money over long periods.

[what were they thinking]

4 Volatility matters. Be honest: Did you scale back your investments in March, when the Dow was below 7000? How about in 2002, when markets were in free-fall? Many people did. And no, it wasn't just folly. On both occasions, share prices were roughly halved from their peak. Many people simply couldn't afford the risk that prices could fall another 50%. Investors felt they were playing Russian roulette.

5 Price matters (my comment: or entry point matters). The biggest problem in 1999 was simply that over the previous 17 years the stock market had already gone up tenfold -- from around Dow 1000 in 1982 to 10000 in 1999. Shares on average were heavily overvalued. No wonder they have been a poor investment since.

6 Don't hurry. Too many investors rushed to "get on board" 10 years ago, and paid the price. Wall Street encourages the habit: Fund managers and brokers like to use the grossly misleading phrase "let's put your money to work" for this reason, even though anyone who "put their money to work" in 1999 lost money. Memo to potential investors: There is never a hurry, never a reason to rush.

7 Don't forget your lifeboats! The biggest problem with the Titanic wasn't that the captain was expecting a safe journey when he set sail. It was that the management was expecting a safe journey when it ordered so few lifeboats. Hope for the best -- but plan for the worst. This is the reason for including nonequities in a portfolio, including inflation-protected government bonds and other assets.

Where are we now? What can we expect for the future?

The good news is that markets are no longer anywhere near as overvalued as they were 10 (or two) years ago. Global markets, which hit a peak of about 25 times forecast earnings in early 2000, are now a more reasonable 16 times. The global dividend yield has doubled to 2.5%. The bad news is shares aren't cheap either. Skeptical value managers -- a rare but valuable breed -- argue shares may be 10% or 20% above fair value.

That's an argument for holding a good amount of shares -- and plenty of dry powder.

Saturday, September 19, 2009

Rosenberg: Too much risk in equity market

David Rosenberg, former chief US economist at Merrill Lynch, thinks the current rally went too far and now the risk of near-term correction outweighs a continuous rally. (highlights and comments are mine)


Never before has the S&P 500 rallied 60% from a low in such a short time frame as six months. And never before have we seen the S&P 500 rally 60% over an interval in which there were 2.5 million job losses. What is normal is that we see more than two million jobs being created during a rally as large as this.

In fact, what is normal is for the market to rally 20% from the trough to the time the recession ends. By the time we are up 60%, the economy is typically well into the third year of recovery; we are not usually engaged in a debate as to what month the recession ended. In other words, we are witnessing a market event that is outside the distribution curve.

While some pundits will boil it down to abundant liquidity, a term they can seldom adequately defined. If it's a case of an endless stream of cheap money, we are reminded of Japan where rates were microscopic for years and the Nikkei certainly did enjoy no fewer than four 50% rallies and over 420,000 rally points in a market that is still more than 70% lower today than it was two decades ago. Liquidity and technicals can certainly touch off whippy tradable rallies, but they don't take you all the way to a sustainable bull market. Only positive economic and balance sheet fundamentals can do that. (comments: but if liquidity and market rally can bring back business confidence, it's not without possibility that business investment will catch up later too.)

Another way to look at the situation is that when you hear and read about "liquidity" driving the market, it is usually a catch-all phrase for "we have no clue" but it sounds good. When we don't have a reasonable explanation for what is driving prices our strategy is to watch from the sidelines and express whatever positive views we have in the credit market and our other income and hedge fund strategies.

As for valuation, well let's consider that from our lens, the S&P 500 is now priced for $83 in operating EPS (we come to that conclusion by backing out the earnings yield that would match the current inflation-adjusted Baa corporate bond yield). That would be nearly double from the most recent four-quarter trend. Not only that, but the top-down estimates on operating EPS, for 2009 are $48.00 for 2009; $52.60 for 2010; $62.50 for 2011; and $81.00 for 2012. The bottom-up consensus forecasts only go to 2010 and even for this usually bullish bunch, operating EPS is seen at $73.00 for 2010, which means that $83.00 is likely a 2011 story. Either way, the market is basically discounting an earnings stream that even the consensus does not see for another two to three years. In other words, this is more than just a fully priced market at this point.

It is, in fact, deeply overvalued at this juncture. Imagine that six months after the depressed lows we have a situation where:

The trailing price-earnings ratio on operating EPS is 26.5x. At the October 2007 highs, it was 18.8x. In addition, when the S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings, history shows that at these high valuation levels, the market declines in the coming year 60% of the time.

The trailing price-earnings ratio on reported EPS is 184.2x. At the October 2007 highs, it was 23.4x. In fact, just prior to the October 1987 crash, the P/E ratio was 20.3x (not intended to scare anyone).

The price-to-dividend ratio is 53x, where it was at the 2007 highs. Again, the market is trading as it if were at a peak for the cycle, not any longer near a trough. Once again, and we don't intend to sound alarmist, the price-to-dividend ratio just prior to the 1987 crash was 12x, and at the time, the S&P 500 was viewed in many circles to be at an extended extreme.

Bullish analysts like to dismiss the actual earnings because they are "depressed" and include too many writeoffs, which of course will never occur again. Fine, on one-year forward (operating) earning estimates, the P/E ratio is now 15.7x, the highest it has been in nearly five years. At the peak of the S&P 500 in the last cycle — October 2007 — the forward P/E was 14.3x, and the highest it ever got in the last cycle was 15.4x. So hello? In just six short months, we have managed to take the multiple above the peak of the last cycle when the economic expansion was five years old, not five weeks old (and we may be a tad charitable on that assessment). As an aside, the forward multiple on the eve of the 1987 stock market collapse was 14x and one of the explanations for the steep correction was that equities were so overvalued and overbought that it was vulnerable to any shock (in that case, it came out of the U.S. dollar market). It certainly was not the economy because that sharp 30% slide took place even with an economy that was humming along at a 4.5% clip.

In other words, valuation may not be the best timing device, but it still matters. If the S&P 500 was in a 700-750 range, de facto pricing in zero to 1% real GDP growth, we would certainly be interested in boosting our allocations towards equities. But at 1,060 and over 4.0% GDP growth effectively being discounted, we will be spectators as opposed to participants, understanding that the key to success is to NOT buy at the peaks. So the strategy is to sit on the sidelines, be selective in our equity choices, and wait for the correction to come or for the fundamentals to catch up with this overvalued, overbought, overextended market. Remember, the reason why the tortoise won the race was because the hare got tired.
One more thing, when people look back at this period, they are very likely going to ask themselves why it was that they never paid attention to the volume data, which, like the bond and money market, never confirmed the veracity of this very flashy bear market rally. We reiterate, Japan enjoyed four of these 50% power surges in the context of a market that is still down over 70% from its highs of two decades ago. So remember, rallies in a bear market are to be rented; never owned. For those that never took the opportunity to get out at the lows today have this glorious chance to do so at much better prices, but the question is whether greed has overtaken their long-term resolve, especially now that Gordon Gekko is making a return to the big screen.

Friday, September 18, 2009

Is salaried doctor the solution?

There gotta be some alternatives to what Obama is proposing.
Incentives, incentives, incentives.

Too hard to break China's savings habit

Why do Chinese save so much? 
BBC reports

Thursday, September 17, 2009

Becker: How much should we care about budget deficit

Insights from Nobel winning Gary Becker, professor of economics at University of Chicago:

Deficits arise when government spending exceeds the revenues raised from various taxes. Deficits add to the stock of government debt. In evaluating the consequences of deficits for an economy, it is first of all crucial to know whether the source of a larger deficit is greater government spending or reduced tax collections, possibly due to reductions in tax rates. The second issue is the burden to the economy of financing the interest payments due on the government debt. I take these issues up in turn.

To the extent that the source of the rise in a deficit is increased government spending, then whether that rise is justified depends on how socially valuable are these government expenditures. By that I mean the social rates of return on these expenditures, such as longer lives for the elderly, relative to the interest cost of raising the required funds, and relative to the returns on other investments in the economy. Much of the increased government spending in different countries during this recession went to help out banks that were in danger of going under. While numerous mistakes were made that will be argued about for a long time, such spending on the whole was necessary in order to limit the financial crisis that had developed.

Other parts of the increase in spending in most countries are far more dubious and may even have harmed their economies. I include in that most of the $800 billion Obama stimulus package, much of which is still not spent even though the brunt of the recession is over This package was promoted as a way to fight the recession, but mainly it is an attempt to re-engineer the economy in the directions of larger government favored by many liberal Democrats. I believe much of this reengineering will hurt the functioning of the economy, and of course at the same time will add to the debt burden.

A very small example was the cash for clunkers program in the US that ended a short time ago. The 19th century French essayist Frederic Bastiat discussed facetiously the gain to an economy when a boy breaks the windows of a shopkeeper since that creates work for the glazier to repair them, and the glazier then spends his additional income on food and other consumer goods. The moral of that story is to hire boys to go around breaking windows! The clunkers program was hardly any better than that (see our discussion of the clunkers program on August 24th).

Deficits also arise automatically during recessions because tax revenues fall as the growth in aggregate incomes slows down, and even becomes negative, as it did during this recession. This automatic effect on deficits during recessions from falling tax revenues is supposed to be balanced by automatic surpluses during prosperity times as tax revenues grow because income are expanding faster. Unfortunately, the period prior to the recession also had budget deficits, even though incomes grew quite fast, because Congress and President Bush pushed for greatly expanded spending.

To turn to the second question, will financing the debt become a serious obstacle to rapid US growth as the current and projected sizable US deficits increase the ratio of government debt to American GDP? That depends on four critical variables: the size of the debt/GDP ratio, the level of interest rates, tax rates, and the rate of productivity growth in the American economy. Suppose the debt held by the public-which excludes government debt held by other government agencies- reaches 100% of present or near term GDP, which is not unlikely. 

The burden on the government budget that this imposes depends on the interest rates on the debt. At an average interest rate of 5%, that means 5% of GDP would go to servicing the debt, which is a little less than 20% of total federal government spending. This might be manageable but it is not trivial. On the other hand, if average interest rates were only 3%, servicing costs would be far more tolerable. In fact, the US has been paying about 3% on its debt, so even a considerable increase of the debt to 100% of GDP would still be manageable. But if the Fed starts raising real interest rates to head off the inflation potential in the $800 billion of excess reserves, the debt burden could become a major problem. Another factor is the savings rates coming from the Asian countries, like China. If their savings decline sharply, that too would raise world interest rates and increase the debt burden for all countries.

Rapid productivity growth and an improved tax structure could save the situation because the expansion of GDP caused by such growth and better taxes lower the ratio of the debt to GDP, and makes financing the debt easier. To maintain rapid productivity growth requires that an economy provide powerful incentives to invest in physical and human capital and R&D. It also requires that Congress and other legislatures do not start growing government spending as GDP grows rapidly. But members of Congress and other legislatures are tempted to use much of the growing tax revenue on their pet projects.

One important determinant of the incentives to invest is the tax rates on the rewards of investments in new knowledge and capital. Rich people should pay a larger share of the tax burden, and they do. However, if the emphasis changes from encouraging investments to redistribution, the poor as well as the rich will suffer. Probably the poor will suffer more since the rich can more their capital and themselves to the many low tax jurisdictions in the world.

Roach: Prevent the next crisis

The Dollar is breaking...(at this moment)

Dollar is breaking to new lows...if we don't repeat another Lehman this fall, I don't see how it can go up.

Gold price jumped above $1000, and stayed there quite nicely.

Innovation in wind energy

Tuesday, September 15, 2009

Bernanke: Recession is likely over

Ben declares so, although what lies ahead is anemic recovery:

U.S. Federal Reserve Chairman Ben Bernanke made his most emphatic declaration yet that the recession has ended, as a separate data release Tuesday showed a rebound in retail sales. But Mr. Bernanke reiterated that tight credit conditions and a soft labor market will prove to be a challenge.

From a technical perspective, the "recession is very likely over at this point," Mr. Bernanke said in a question-and-answer session at the Brookings Institution.

But he added that even if recovery is under way, the economy will still seem weak because credit conditions remain tight and any decline in the unemployment rate will probably happen gradually. He noted that one risk is that the economy will grow in the second half of 2009, but not enough to trigger a rapid recovery in employment.

If there is only moderate economic growth, unemployment "will be slow to come down," he said. "It will come down, but it will take some time."

China's GEM

China's Nasdaq market is ready to launch (source: wsj):

The countdown has begun for the launch of China's Nasdaq-style stock market, with the country's securities regulator poised to announce the first batch of companies approved for listings on the Growth Enterprise Market as soon as Thursday.

If everything goes according to plan, the GEM, which will be on the Shenzhen Stock Exchange and is aimed at funding technology- and innovation-driven start-ups, would open for business as early as mid-October, analysts said.

Hopes are that the GEM, which authorities have considered for nine years, will open up a fund-raising channel for cash-hungry start-ups that are deemed critical for Beijing's effort to restructure its export- and manufacturing-dependent economy in the long run. Such smaller firms have had little access to an avalanche of new lending in China this year.

Down the line, supporters say the GEM could prove a rival to the likes of New York's Nasdaq Stock Market and London's Alternative Investment Market as a place for small Chinese companies to find backing, though precedents for such markets in Asia aren't too encouraging.

Although the GEM has been positioned as a high-risk, high-growth marketplace, a look at the seven companies whose initial public offerings are being reviewed suggests Beijing is seeking to ensure a stable start for the exchange by selecting more mature firms, including a state-owned enterprise.

The China Securities Regulatory Commission said Sunday that it will start reviewing GEM-related IPO applications from Thursday, with seven firms chosen for the first round, including Beijing Lanxum Technology Co., Beijing Ultrapower Software Co. and Lepu Medical Technology (Beijing) Co.

The companies could raise a combined 2.27 billion yuan ($332.4 million) from their IPOs, according to a calculation based on information in their prospectuses.

"Most of the seven companies look very similar to those previously seeking a listing on the Small and Medium Enterprise Board in terms of size and industry," said Li Bin, an analyst at Guolian Securities, who said it is likely the companies were originally SME Board applicants, which generally are relatively well established and not in the high-risk category that the GEM is supposed to target.

The average scale of the seven IPOs falls into the range of 200 million yuan to 500 million yuan considered typical for a new listing on the SME Board, which is also on the Shenzhen exchange.

So far, 149 companies have applied for GEM listings, and analysts said those with sounder financial health and more stable earnings are expected to go through first.

Indeed, Mr. Li said most of the seven companies being reviewed this week don't qualify as innovation-driven start-ups, neither in terms of the nature of their businesses nor their shareholding structure.

In a market meant as a playground for mostly private enterprises, one hardly expects to see a state-owned company, but 53.9% of Lepu Medical Technology, a medical appliances maker, is indirectly held by China Shipbuilding Industry Corp. through two of its units.

The CSRC has said the GEM would mainly serve companies in businesses such as renewable energy, biomedicine, electronic information and environmental protection.

Monday, September 14, 2009

Hatzius on the state of the economy

Jan Hatzius, Chief US economist at Goldman Sachs talks about his view on the state of the US economy

link to the video
(source: FT)

The legacy of John Mack

The legacy of John Mack and the challenges ahead for Morgan Stanley.

Have we learned lesson from Lehman's fall?

Ken Rogoff fears not:

The Confidence Game

CAMBRIDGE – This month marks the one year anniversary of the collapse of the venerable American investment bank, Lehman Brothers.  The fall of Lehman marked the onset of a global recession and financial crisis the likes of which the world has not seen since the Great Depression of the 1930's. After one year, trillions of dollars in public monies, and much soul searching in the world's policy community, have we learned the right lessons?  I fear not.

The overwhelming consensus in the policy community is that if only the government had bailed out Lehman, the whole thing would have been a hiccup and not a heart attack.  Famous investors and leading policymakers alike have opined that in our ultra-interconnected global economy, a big financial institution like Lehman can never be allowed to fail. No matter how badly it mismanages its business – Lehman essentially transformed itself into a real estate holding company totally dependent on a continuing US housing bubble – the creditors of a big financial institution should always get repaid.  Otherwise, confidence in the system will be undermined, and chaos will break loose.

Having reached the epiphany that financial restructuring must be avoided at all costs, the governments of the world have in turn cast a huge safety net over banks (and whole countries in Eastern Europe), woven from taxpayer dollars.

Unfortunately, the conventional post-mortem on Lehman is wishful thinking.  It basically says that no matter how huge the housing bubble, how deep a credit hole the United States (and many other countries) had dug, and how convoluted the global financial system, we could have just grown our way out of trouble.  Patch up Lehman, move on, keep drafting off of China's energy, and nothing bad ever need have happened.

The fact is global imbalances in debt and asset prices had been building up to a crescendo for years, and had reached the point where there was no easy way out.  The United States was showing all the warning signs of a deep financial crisis long in advance of Lehman, as Carmen Reinhart and I document in our forthcoming book This Time is Different:  Eight Centuries of Financial Folly

Housing prices had doubled in a short period, spurring American consumers to drop any thought of saving money.  Policymakers, including the US Federal Reserve, had simply let the 2000s growth party go on for too long.  Drunk with profits, the banking and insurance industry had leveraged itself to the sky. Investment banks had transformed their business in ways their managers and boards clearly did not understand.

It was not just Lehman Brothers.  The entire financial system was totally unprepared to deal with the inevitable collapse of the housing and credit bubbles. The system had reached a point where it had to be bailed out and restructured.  And there is no realistic political or legal scenario where such a bailout could have been executed without some blood on the streets.  Hence, the fall of a large bank or investment bank was inevitable as a catalyst to action.

The problem with letting Lehman go under was not the concept but the execution.  The government should have moved in aggressively to cushion the workout of Lehman's complex derivative book, even if this meant creative legal interpretations or pushing through new laws governing the financial system.  Admittedly, it is hard to do these things overnight, but there was plenty of warning.  The six months prior to Lehman saw a slow freezing up of global credit and incipient recessions in the US and Europe.  Yet little was done to prepare.

So what is the game plan now?  There is talk of regulating the financial sector, but governments are afraid to shake confidence.  There is recognition that the housing bubble collapse has to be absorbed, but no stomach for acknowledging the years of slow growth in consumption that this will imply. 

There is acknowledgement that the US China trade relationship needs to be rebalanced, but little imagination on how to proceed.  Deep down, our leaders and policymakers have convinced themselves that for all its flaws, the old system was better than anything we are going to think of, and that simply restoring confidence will fix everything, at least for as long as they remain in office.

The right lesson from Lehman should be that the global financial system needs major changes in regulation and governance. The current safety net approach may work in the short term but will ultimately lead to ballooning and unsustainable government debts, particularly in the US and Europe. 

Asia may be willing to sponsor the west for now, but not in perpetuity.  Eventually Asia will find alternatives in part by deepening its own debt markets.  Within a few years, western governments will have to sharply raise taxes, inflate, partially default, or some combination of all three.  As painful as it may seem, it would be far better to start bringing fundamentals in line now.  Restoring confidence has been helpful and important. But ultimately we need a system of global financial regulation and governance that merits our faith.

Markets can be wrong and the price is not always right

Richard Thaler, professor at U. of Chicago, chastises the foundation of the modern finance, the Efficient Market Hypothesis (or EMH) (source: FT),

I recently had the pleasure of reading Justin Fox's new book The Myth of the Rational Market . It offers an engaging history of the research that has come to be called the "efficient market hypothesis". It is similar in style to the classic by the late Peter Bernstein, Against the Gods. All the quotes in this column are taken from it. The book was mostly written before the financial crisis . However, it is natural to ask if the experiences over the last year should change our view of the EMH.

It helps to start with a quick review of rational finance. Modern finance began in the 1950s when many of the great economists of the second half of the 20th century began their careers. The previous generation of economists, such as John Maynard Keynes, were less formal in their writing and less tied to rationality as their underlying tool. This is no accident. As economics began to stress mathematical models, economists found that the simplest models to solve were those that assumed everyone in the economy was rational. This is similar to doing physics without bothering with the messy bits caused by friction. Modern finance followed this trend.

From the starting point of rational investors came the idea of the efficient market hypothesis, a theory first elucidated by my colleague and golfing buddy Gene Fama. The EMH has two components that I call "The Price is Right" and "No Free Lunch". The price is right principle says asset prices will, to use Mr Fama's words "fully reflect" available information, and thus "provide accurate signals for resource allocation". The no free lunch principle is that market prices are impossible to predict and so it is hard for any investor to beat the market after taking risk into account.

For many years the EMH was "taken as a fact of life" by economists, as Michael Jensen, a Harvard professor, put it, but the evidence for the price is right component was always hard to assess. Some economists took the fact that prices were unpredictable to infer that prices were in fact "right". However, as early as 1984 Robert Shiller, the economist, correctly and boldly called this "one of the most remarkable errors in the history of economic thought". The reason this is an error is that prices can be unpredictable and still wrong; the difference between the random walk fluctuations of correct asset prices and the unpredictable wanderings of a drunk are not discernable.

Tests of this component of EMH are made difficult by what Mr Fama calls the "joint hypothesis problem". Simply put, it is hard to reject the claim that prices are right unless you have a theory of how prices are supposed to behave. However, the joint hypothesis problem can be avoided in a few special cases. For example, stock market observers – as early as Benjamin Graham in the 1930s – noted the odd fact that the prices of closed-end mutual funds (whose funds are traded on stock exchanges rather than redeemed for cash) are often different from the value of the shares they own. This violates the basic building block of finance – the law of one price – and does not depend on any pricing model. During the technology bubble other violations of this law were observed. When 3Com, the technology company, spun off its Palm unit, only 5 per cent of the Palm shares were sold; the rest went to 3Com shareholders. Each shareholder got 1.5 shares of Palm. It does not take an economist to see that in a rational world the price of 3Com would have to be greater than 1.5 times the share of Palm, but for months this simple bit of arithmetic was violated. The stock market put a negative value on the shares of 3Com, less its interest in Palm. Really.

Compared to the price is right component, the no free lunch aspect of the EMH has fared better. Mr Jensen's doctoral thesis published in 1968 set the right tone when he found that, as a group, mutual fund managers could not outperform the market. There have been dozens of studies since then, but the basic conclusion is the same. Although there are some anomalies, the market seems hard to beat. That does not prevent people from trying. For years people predicted fees paid to money managers would fall as investors switched to index funds or cheaper passive strategies, but instead assets were directed to hedge funds that charge very high fees.

Now, a year into the crisis, where has it left the advocates of the EMH? First, some good news. If anything, our respect for the no free lunch component should have risen. The reason is related to the joint hypothesis problem. Many investment strategies that seemed to be beating the market were not doing so once the true measure of risk was considered. Even Alan Greenspan, the former Federal Reserve chairman, has admitted that investors were fooled about the risks of mortgage-backed securities.

The bad news for EMH lovers is that the price is right component is in more trouble than ever. Fischer Black (of Black-Scholes fame) once defined a market as efficient if its prices were "within a factor of two of value" and he opined that by this (rather loose) definition "almost all markets are efficient almost all the time". Sadly Black died in 1996 but had he lived to see the technology bubble and the bubbles in housing and mortgages he might have amended his standard to a factor of three. Of course, no one can prove that any of these markets were bubbles. But the price of real estate in places such as Phoenix and Las Vegas seemed like bubbles at the time. This does not mean it was possible to make money from this insight. Lunches are still not free. Shorting internet stocks or Las Vegas real estate two years before the peak was a good recipe for bankruptcy, and no one has yet found a way to predict the end of a bubble.

What lessons should we draw from this? On the free lunch component there are two. The first is that many investments have risks that are more correlated than they appear. The second is that high returns based on high leverage may be a mirage. One would think rational investors would have learnt this from the fall of Long Term Capital Management, when both problems were evident, but the lure of seemingly high returns is hard to resist. On the price is right, if we include the earlier bubble in Japanese real estate, we have now had three enormous price distortions in recent memory. They led to misallocations of resources measured in the trillions and, in the latest bubble, a global credit meltdown. If asset prices could be relied upon to always be "right", then these bubbles would not occur. But they have, so what are we to do?

While imperfect, financial markets are still the best way to allocate capital. Even so, knowing that prices can be wrong suggests that governments could usefully adopt automatic stabilising activity, such as linking the down-payment for mortgages to a measure of real estate frothiness or ensuring that bank reserve requirements are set dynamically according to market conditions. After all, the market price is not always right.

Sunday, September 13, 2009

Uneven "recovery" in housing

Distressed sales now make up around two-thirds of transactions in Las Vegas and Miami; even in midwest area, where housing had relatively less drop, 39% of mortgage owners have negative equity (or underwater).  At last, the market for the more expensive houses (500K and above) is simply not moving.  It looks like still too early for housing recovery.  (source: WSJ)

The U.S. housing market was unified by the bust. After peaking in 2006, home prices across the country joined the march downward. Are investors prepared for a return to more normal times?

[u.s. housing recovery]

It wasn't long ago that a nationwide price decline was considered almost impossible by many, not having been observed since the Great Depression. Supply and demand have usually dictated prices on a local level.

And yet, now that there are signs of stabilization, some investors appear to be hoping for prices to recover across the board. Better housing data, such as a rise in the S&P/Case-Shiller index have helped stocks extend a heady rally. A one-time government tax deduction for first time buyers and seasonal demand for homes have added a timely boost.

But a look on a regional level shows a different story. The likes of overbuilt Las Vegas and Miami have yet to see prices turn. There, distressed sales now make up around two-thirds of transactions, according to the National Association of Realtors.

Such distressed sales, mainly foreclosures, are discounted on average 15% to 20%, dragging overall prices lower. Granted, that may set the stage for higher prices when foreclosures slow, but there still is little sign that inventory is near equilibrium.

On the face of it, other parts of the country appear to have better traction. Take the Midwest. Cleveland saw prices rise 10% in the three months through June, the fastest of any location in S&P/Case Shiller's 20-city index.

Midwestern states will likely face some hiccups in any recovery. The NAR reckons the Midwest still has 8.0 months' supply of single-family homes on the market between $100,000 and $250,000, compared with 8.9 months a year ago. During the 1990s, the average nationwide was 6.6 months.

That supply could be tough to clear. The many buyers underwater on existing homes will struggle to move, even to a cheaper home. In Ohio, for instance, some 39% of mortgages have negative equity, or are attached to properties worth less than outstanding debt, according to research firm First American CoreLogic. The national average is 32%.

Demand may stay especially weak for homes in high price categories. The NAR says just 2.5% of the 460,000 homes sold in July cost $500,000 or more. In the fourth quarter of 2004, such homes accounted for 11.2% of the total.

That presents potential for higher average sales prices if more high-end sales are completed. But, with "jumbo" mortgages harder to come by, demand is likely to remain concentrated at lower price levels.

Of course, stability in some housing markets is refreshing. But after the summer house-hunting season ends, the sum of a fragmented market is unlikely to be a unified rise.

Treasuries or gold?

Which is a better investment, under different scenarios?  WSJ analyzes:

Is the outlook for the world economy dark enough for gold to continue to glitter?

Remarkably, the gold price has appreciated 12% since April, a period during which financial-meltdown fears appear to have receded and investors have rushed back into riskier assets. Gold's resilience suggests continuing demand for an asset that could outperform in worst-case scenarios.

But not every difficult economic outcome is the same. That is something investors need to remember as they decide whether gold -- rather than Treasurys -- really is the best disaster hedge.

Treasurys start with several advantages. They produce an income stream, whereas gold doesn't. And, although Treasurys would be hit if there is a strong economic rebound with low inflation, gold would likely be hammered.

[gold prices] 

Next, Treasurys actually did better than gold in the fear-drenched period at the end of last year. The Merrill Lynch price index for the 10-year Treasury jumped 11.6% from September through the end of 2008. The Comex gold price was up 6.6% over the same period, and it sold off sharply in the middle of the meltdown. That last fact suggests gold benefits when markets are functioning -- like now -- but the metal, like other assets, can fall when markets close down.

In other words, Treasurys could trump gold in a Japan-like environment, where deflation pushes up real yields but isn't high enough to cause serious stress on the financial system and the wider economy.

But gold has a big friend in Western central banks, especially the Federal Reserve, which is still printing enormous amounts of dollars to support key markets. This makes the inflation outlook uncertain, helping gold and hurting currencies like the dollar.

The printing looks set to continue. Ominously, this weekend, the G-20 said central-bank liquidity support "will need to remain in place for some time."

One area where that support could stay in place for a long time is for the U.S. housing market. Right now, there is almost no private-sector demand for nonconforming residential mortgages, reflected in the fact that the U.S. government has effectively or explicitly guaranteed as much as 85% of all mortgages originated this year, according to Inside Mortgage Finance. In turn, the Fed is buying nearly 80% of government-backed mortgages packaged in securities. If it pulls back, house prices could resume their slide, triggering more foreclosures and losses for banks.

Finally, soaring fiscal deficits favor gold. The IMF expects G-7 countries to show a combined fiscal deficit equivalent to 10.36% of GDP this year, more than double the level following the 1990-91 recession. True, it is impossible to time a fiscal Armageddon bet. The yen has stayed strong even as Japanese government borrowing has exploded over the past 20 years.

But government finances are now deteriorating in most developed countries.

For pessimists, if we're in for a Japanese-style deflationary bust, buy Treasurys. For other disaster scenarios, go for gold.

Saturday, September 12, 2009

How big is China's Green Energy

Source: BoFIT

Although the relative share of electrical power generated by renewable energy systems is still small in China, the country has made remarkable progress in adopting new approaches in recent years. The amount of wind-generated electricity quadrupled between 2006 and 2008, and today China has the world's fourth largest wind power generation capacity after the US, Germany and Spain. Large dam projects have also helped double hydro-power generation since 2002. Solar power use has increased dramatically along with incentives such as direct subsidies to e.g. building owners who install solar panels on their buildings. Moreover, China is planning to construct one of the world's largest solar fields in Inner Mongolia.

The introduction of renewable power technologies has not been without difficulties. Despite state support for construction of wind farms, companies that operate the electricity grid have little incentive bring wind farms, which are often located in remote areas, onto the grid. By some estimates, as much as 20 % of wind power currently generated in China is still off-grid and capacity utilization of wind farms has been lower than expected. There have also been problems with hydro-power projects as China struggles with droughts and uncertainty over the long-term environmental impacts of huge dams.

Despite the rapid rise of sustainable energy systems, they still generate a small share of China's total electricity (see chart). Hydro-power accounts for 16 % of electrical power generation, and wind just 0.4 %. Coal, in contrast is the basis of more that 80 % of China's power generation. China's goal is to raise the share of electricity generated by renewable systems to over 20 % by 2020.

China is the world's largest emitter of carbon dioxide. A substantial amount of these emissions are generated by coal-burning power plants. China's future energy production will continue to rely heavily on coal-fired power plants and China has not committed to Kyoto treaty emission targets. International climate talks will continue in December at the Climate Summit in Copenhagen.

China's CO2 emissions should fall slightly as the country makes gains in energy efficiency and its worst-polluting coal-fired power plants are shut down. A target of the cur-rent five-year plan (2006–2010) is to reduce energy consumption by 20 % relative to China's per capita GDP. Although progress towards this decrease has been achieved, it appears unlikely that the target will be met.
Although the state has passed an energy saving law and launched a raft of energy-saving programs, heavy regulation of electricity prices erodes the incentive to be energy efficient. Moreover, there has not been political enthusiasm for deregulation of energy prices.

Friday, September 11, 2009

Obama speech on health care reform

Can we get it done this time?

link to the speech video

source: NYT

Tuesday, September 08, 2009

Dollar debate: bull vs. bear

China is trying very hard to diversify away from US dollar

There is not much China can do, but purchasing IMF notes is a good away to increase its influence on international monetary policy.

The Managing Director of the International Monetary Fund (IMF), Mr. Dominique Strauss-Kahn, and the Deputy Governor of the People's Bank of China, Mr. Yi Gang, have signed an agreement under which the People's Bank of China would purchase up to SDR 32 billion (around US$50 billion) in IMF notes.

The note purchase agreement is the first in the history of the Fund, and follows the endorsement by the Executive Board on July 1, 2009 of the framework for issuing notes to the official sector. The Chinese authorities had expressed their intention to invest up to US$50 billion in IMF notes in June (see Press Releases No. 09/204 and No. 09/248).

The agreement offers China a safe investment instrument. It will also boost the Fund's capacity to help its membership — particularly the developing and emerging market countries — weather the global financial crisis, and facilitate an early recovery of the global economy.

Monday, September 07, 2009

Shades of gray in employment

The unemployment rate is near 10%. Every age group is seeing decline of employment except for the age group that is above 55. What happened?  This WSJ piece explains --- It's not merely demographic change.

The Who famously sang they hoped they'd die before they got old. Clearly, they didn't want a proper job.

So far in this recession, 6.6 million jobs have been lost on a seasonally adjusted basis. That wipes out six of 10 jobs created in the last, unusually jobless, economic upswing. Every age group has lost jobs.

[job losses]

Except, that is, the cohort aged 55 and over, which has gained nearly one million positions. What's more, over-55s accounted for two-thirds of net jobs created in the upswing.

This has less to do with gray flair and more with a statistical wrinkle. The first of the postwar baby boomers hit official retirement age in 2011. That demographic bulge has been rolling through the age structure -- in and out of the workplace -- through this decade. According to Census Bureau estimates, the overall population age 55 to 64 grew by 9.4 million between July 2001 and July 2008. That isn't dissimilar to the roughly eight million increase in the ranks of employed over-55s between November 2001 and now.

But the figures point to more than just a demographic change. Over the same time period, the proportion of over-55s in employment rose five percentage points, possibly reflecting a need to re-enter the job market after the bursting of a tech bubble and a housing bubble damaged their net worth.

Meanwhile, labor participation fell for every other age group. For those age 16 to 24, for example, the rate fell almost 10 percentage points, to under half, even as that population group expanded. A graying work force focusing on rebuilding its nest egg while the young struggle for entry doesn't bode well for an economy dependent on sprightly consumers.

David Rosenberg also has a wonderful graph on this:

(click to enlarge)

Why individual investors sit tight on their 401(k)s?

Part of it is individual's strong belief of the theory that stocks always outperform other assets in the long run; part of it is simple inertia (source: WSJ):

There are bears. There are bulls. And there are sitting bulls.

These are the legions of 401(k) investors who don't merely buy and hold; they buy, hold and sit stock-still. Even as the U.S. stock market fell 55% between October 2007 and March 2009, these people barely budged. Among the more than three million 401(k) participants served by Vanguard Group, 17% were 100% in stocks in 2007; at year-end 2008, 16% still were. Of the 11.2 million participants served by

[Intelligent Investor]

Fidelity Investments, 15% still have every penny in their 401(k) invested in stocks, including 14% of those between the ages of 60 and 64.

The sitting bulls present a problem for hedge-fund managers and other professional investors who have argued that all it would take to shake individual investors' grip on stocks was a good old-fashioned bear market.

To be sure, the share of U.S. households that own stocks in any account has fallen from 53% in 2001 to around 45% in 2008, according to the Investment Company Institute and the Securities Industry and Financial Markets Association. Since 2007, 401(k) investors at both Fidelity and Vanguard have lowered the rate of new contributions they are putting into stocks.

But those trends hardly constitute a stampede. At Vanguard, says Stephen Utkus of the Vanguard Center for Retirement Research, only 16% of 401(k) investors made any trades in 2008, barely up from 15% in 2007 and down from 20% in 2004. That includes rebalancing across funds to restore an asset mix to target levels.

"It is kind of striking," Mr. Utkus says. "We had the most drastic market decline since the Depression, we nearly had a total collapse of the global financial system, and all that caused most people not to do much at all."

After the Great Crash of 1929, individual investors abandoned the stock market for a generation. What keeps today's sitting bulls from running off?

First, these people are largely doing what they have been told, by researchers who have argued that stocks are risk-free in the long run, by mutual-fund companies that earn higher fees on stock funds and by stock-market advocates in the financial media.

Another factor is what Mr. Utkus calls the "contribution effect." For workers who are young, newly hired or lower-paid, falling market values are counteracted by the new cash pumped in with each payroll contribution. More than one-third of Vanguard's 401(k) investors didn't lose money in 2008, while another 10th lost 10% or less. These people were barely scathed by the stock-market crash.

Furthermore, 401(k) contributions are automatic and withdrawals are often decades in the future, reducing the apparent need for action today. Sir Isaac Newton's first law of motion might be reapplied to 401(k) investing: An investor at rest tends to stay at rest, even when acted upon by an unbalanced force.

This bovine behavior is driven partly by a very human need to simplify decisions that feel complex. Forced to choose how much money they want to put into stocks, many 401(k) investors don't treat it as a decision about how much risk they wish to take. Instead, they look for obvious rules of thumb. If you like stocks, why not put 100% of your money into them? If you don't, then why not set a zero allocation to stocks? And once you pick a nice round number, why change it?

Accounting professor Shlomo Benartzi of UCLA studied a large sample of investors who filled out a risk-tolerance questionnaire for a major 401(k) provider. Only 7% described themselves as aggressive; yet 33% invest as if they are, putting 80% to 100% of their 401(k) into stocks.

So inertia is often a state of mind, rather than a deliberate choice. It worked well in the 1980s and 1990s, and again over the past six months as the market partially rebounded from its collapse. For the past decade as a whole, it hasn't worked well. So investors should be patient, but not catatonic; they should rebalance annually to sell some of what has gone up and buy some of what has gone down.

If stocks are halved again, or we get another decade of poor returns, the sitting bulls might finally get up and leave the field. But nothing short of that seems likely to make them budge. Bears can maul most livestock, but they are no match for sitting bulls.