Japan scares me

Japan has the highest Debt-to-GDP ratio in the world.   According to IMF its predicted to top 245%.  Rates have been dropping for 25years! Yet, interest payments have risen for the last 25years.  Recently inflation expectations have bumped up rates.  The 10-year is up 28bps relative to last month April.  As yields move higher Japan becomes a ticking time bomb and will not be able to service its debt. 

At their current level, if rates hit 2.8% then 100% of tax revenues to go towards interest payments only!


Japan is the 3rd largest economy in the world. 

This scares me.






Herman Venegas

Weekly Review 10.30.2012

 

This was a record setting week! Literally 

Europe
Eurozone hit a record high debt of 90% from all 17 countries that use the single euro currency.  This is the highest level since 1999 when the EU currency was first implemented.
"The euro area economy remains stuck in a rut" said James Ashley, Sr. European economicst at RBC Capital Markets.
According to the Eurostat, five countries are in recession Greece, Spain, Italy, Portugal and Cyprus.  Many analyst expect the Eurozone to slip back into a recession next month when the official numbers are released. (recession is defined as two downward quarters of negative growth in a row)
Furthermore, PMI remains lowest in three years at 45.8  We can see this with BMW and VW, their exports have taken a hit on YoY basis. 


China
PMI- HSBC report showed Wednesday rising new orders.  3 month upward trend shows that the economy is slowly picking up.  However, this is not sustainable given US potentially falling off the cliff and the meltdown in Europe.  Nonetheless, PMI was 47.9(August)  49.2(September) and 49.8 in October.  This is still below 50 but indicates slow improvement and a moderate rebound of the worlds second largest economy.  Weak external demand and a slack job market are key factors, therefore one should expect more easing policies to secure recovery.

China's yuan reached a 19 year high against the US dollar.  Currency hit 6.2417 yuan per dollar, it has been appreciating since QE3 and the ECB bond buying plan.   HK monetary authority has injected more than $14B to stabilize Curreny.  Could this be the start of a currency war? Last weeks review we talked about Brazil's finance minister publicly scolding the US selfish actions at the IMF conference in Tokyo.   Chinese exports are sure to take a beating. 

Japan
Japan adds $9.4B to stimulus program to bump up growth as bond investors told government they were worried about delays and more spending.  Finance minister said this was necessary because Japan would run out of money if the bill was not passed.  This is only estimated to boost GDP by .1%.  Japan has the highest debt level among developed nations and has experienced 2 lost decades.  According to world renowned economists Rogoff and Reinhart  a Country with debt-to-gdp in excess of 90% is unsustainable.  Japan is at over 200%. (see book "This time is Different")

United States
Fiscal Cliff can be much worst than it is.  Many economist think every dollar of deficit reduction will subtract nearly the same amount from economic growth.  The IMF suggest 1$ could drain as much as $1.70.  With interest rates at near zero the pain will be much worse. Bernanke has acknowledged he would not be able to fully offset the pain if the economy runs into the fiscal cliff.  


The “fiscal cliff” and long-term government deficit issues are weighing heavily on the minds of finance professionals, and they do not expect business conditions to improve regardless of the results of the Nov. 6 presidential election.
Three-fourths of 949 executives who responded to a survey at the annual conference of the Association for Financial Professionals (AFP) this month reported that they believe overall economic conditions will weaken if various tax law provisions expire and mandated government spending cuts go into effect as scheduled in January 2013.
Respondents rated implementing changes to avoid the fiscal cliff as the second-most important issue for federal elected representatives to focus on after the election. The most important issue to respondents was resolving long-term government fiscal and deficit issues, identified by 63% of finance professionals in the survey.

Herman Venegas
 

Weekly Review 10.22.2012

All eyes were on the Second Presidential Debate.

Both Romney and Obama delivered strong punches tackling issues such as unemployment, oil and energy.  All said and done, Mitt Romney is in the lead in the gallop polls 52% to 45%.

Central Bankers and Government officials met up in Tokyo for the annual IMF conference.  (http://www.imf.org/external/am/2012/) The IMF lowered its GDP outlook on the global world economy.  The major theme talked about was fiscal unity among political leaders hinting towards the EU leaders.

Also, Bernanke addressed critics abroad saying stronger growth in the United States bolsters global prospects as well, countering the likes of Brazil's Finance Minister Guido Mantega who has labeled the Fed's latest stimulus effort "selfish".
Critics say the Fed's unorthodox policies weaken the U.S. dollar and boost the currencies of developing countries, hurting their ability to export.

Canada has blocked Malaysian state oil firm Petronas’ C$5.17 billion bid for gas producer Progress Energy Resources in a surprise move that could signal problems for a much larger Chinese deal in the country’s energy sector.
Canada’s announcement late on Friday, minutes before a deadline, was a blow to Petronas whose domestic oil supplies are shrinking and which has been seeking to boost its resources beyond Malaysia and volatile areas such as Sudan.
It also raises doubts over Chinese oil group CNOOC’s C$15.1 billion offer for oil producer Nexen and could weigh on other Canadian firms hoping for foreign investment to tap their vast energy reserves.
Any rejection of the CNOOC bid would likely damage trade ties Canada has been trying to build with China, underlining political sensitivity to Chinese corporate expansion in North America.
http://www.vancouversun.com/business/Canada+blocks+billion+Petronas+Progress+deal+with+video/7422103/story.html#ixzz2A4gWGYes

Google's earnings were released ahead of schedule.  The stock plummeted -$3.12.  Why? according to experts mobile has been a mixed blessing. Smartphones and tablets are bringing in new users — and the advertisers that follow them — but it makes less money on mobile ads than on desktop ads.

For a  list of companies who released earnings this week click here.   http://www.earnings.com/highlight.asp?client=cb

"Inflation is always and everywhere a monetary phenomenon." - Milton Friedman

Last week Ben Bernanke announced another round of quantitative easing (QE3).  This time around the FED's have planned to buy $40Billion of MBS per month.  That's another $480B per year.  Three rounds of massive stimulus have led many people to become concerned about inflation.  

As quoted by Milton Friedman “Inflation is always and everywhere a monetary phenomenon.”  Just ask Zimbabweans who have stopped publishing their inflation rates; last recorded rate was on 2008 Mid-Nov. of 89,700,000,000,000,000,000,000%.

What is inflation?

Simply put, inflation is a decline in ones purchasing power.  As more money is made readily available to consumers (money supply) and is circulated in the system (velocity) the prices of goods and services start to increase making it costlier for you and me. 

Lets take a look at how much money is currently in the system...

It doesn't get any clearer than this!  The massive spike represents billions of dollars freshly printed off the printing press starting sometime around 2008. 

Where is all this money hiding?

Banks have tremendously expanded their balance sheets in the recent years.  Taking a closer look at money in circulation we can see that banks have been hesitant to loan mortgages and consumers unwilling to apply for loans.  Even with ultra low interest rates, people are not taking on debt.

What does this all mean?

The spark!  So much fuel has been pumped into the system in the form of money that a spark to the economy will ignite the fire and then..... an explosion.  Once the economy gets heated and starts to pick up there will be big surprises in inflation rates.  Key numbers to be aware of are employment, consumer lending and housing starts.  These numbers will be a good indicator of the spark.   The Federal Reserve expects the economy to pick up by 2015. 

Portfolio Hedging Strategies

Protecting your investments is important! From a portfolio standpoint if you were holding a 60/40 equity bond portfolio throughout the highest inflation peaks of WWI, WWII and the 1970’s you would have a negative 10 year return real return on your portfolio.  

How can you deliver equity like returns in times of inflation?

Benjamen Graham the father of financial analysis has stated two plays.

     1. Inflation Protected Bonds   

          2. Real Assets (Gold, Commodity Futures, Natural Resource Stocks, REITS)

Taking a closer look at these assets.  I have provided their sensitivity (Beta) to inflation surprises        

Data - (1970-2011)

Assets	Beta
Gold	11.5
Commodity Futures	7.1
Natural Resource Stocks	3.0
Inflation protected bonds	0.8
Real Estate Investment Trusts	(1.5)

*inflation surprise is the difference between actual and real inflation

Bottom Line:  Protect your wealth! and be ahead of the curve.  A RAPID rise in inflation will surprise many investors.  Consider holding Gold, Commodity Futures, Natural Resource Stocks and Inflation Protected Bonds as these assets have preformed very well in inflationary periods.  

Spot Gold on Feds announcement

Herman Venegas

September.17.2012