One of the dirty little secrets of the stock market rally is that the rising corporate profits that powered it are largely phantom profits. Why are they phantom? Because they are artifacts of currency devaluation, not an increase in efficiency or production of goods and services. Though few domestic observers make mention of it, the large, global U.S.-based corporations are now dependent on non-U.S. sales for about 40% of their revenues (50% and up for many companies) and virtually all their profit growth. Overseas sales are made in the local currency: the euro, yen, renminbi, Australian dollar, Canadian dollar and so on, and the profits are stated in U.S. dollars on corporate profit and loss statements. In 2002, 1 euro of profit earned by a U.S. global corporation equaled $1 in profit when converted to U.S. dollars. That same 1 euro profit swelled to $1.60 in 2008 as the U.S. dollar depreciated against the euro. That $ .60 of profit was phantom, an artifact of the depreciating dollar; it did not result from a higher production of goods and services or greater efficiencies.
A certain flavor of econometric model dominates conventional portfolio management and financial analysis. This model can be paraphrased thusly: seasonally adjusted economic data such as the unemployment rate and financially derived data such as forward earnings and price-earnings ratios are reliable guides to future economic growth and future stock prices....If this model is so accurate and reliable, why did it fail so completely in 2008 when a visibly imploding debt-bubble brought down the entire global economy and crashed stock valuations? Of the tens of thousands of fund managers and financial analysts who made their living off various iterations of this econometric model, how many correctly called the implosion in the economy and stock prices? How many articles in Barrons, BusinessWeek, The Economist or the Wall Street Journal correctly predicted the rollover of stocks and how low they would fall? Of the tens of thousands of managers and analysts, perhaps a few dozen got it right (and that is a guess--it may have been more like a handful). In any event, the number who got it right using any econometric model was statistical noise, i.e. random flecks of accuracy. The entire econometric model of relying on P-E ratios, forward earnings, the unemployment rate, etc. to predict future economic trends and future stock valuations was proven catastrophically inadequate. The problem is these models are detached from the actual drivers of growth and stock valuations.
Much has been made of today's Reuters story how "Iran turns to barter for food as sanctions cripple imports" in which we learn that "Iran is turning to barter - offering gold bullion in overseas vaults or tankerloads of oil - in return for food", and whose purpose no doubt is to demonstrate just how crippled the Iranian economy is as a result of the ongoing US embargo. Incidentally this story is 100% the opposite of the Debka-spun groundless disinformation from a few weeks ago that India was preparing to pay for Iran's oil in gold (they got the asset right, but the flow of funds direction hopelessly wrong). While there is certainly truth to the fact that the US is actively seeking to destabilize the local government, we wonder why? After all as the opportunity cost for the existing regime to do something drastic gets ever lower as the popular resentment rises, leaving the local administration with few options but to engage either the US or Israel. Unless of course, this is the ultimate goal. Yet going back to the Reuters story, it would be quite dramatic, if only it was not the case that Iran has been laying the groundwork for a barter economy for many months now, something which various other analysts perceive as the basis for the destruction of the petrodollar system. Perhaps regular readers will recall that back in July, we wrote an article titled "China And Iran To Bypass Dollar, Plan Oil Barter System." Specifically, we wrote that "according to the FT, China has decided to commence a barter system in which Iranian oil is exchanged directly for Chinese exports. The net result: not only a slap for the US Dollar, but implicitly for all fiat intermediaries, as Iran and China are about to prove that when it comes to exchanging hard resources for critical Chinese goods and services, the world's so called reserve currency is completely irrelevant." Seen in this light the fact that Iran is actually proceeding with a barter system, something that had been in the works for quite a while, actually puts the Reuters story in a totally different light: instead of one predicting the imminent demise of the Iranian economy, the conclusion is inverted, and underscores the culmination of what may have been an extended barter preparation period, has finally gone from beta to (pardon the pun) gold, and Iran is now successfully engaging in global trade without the use of the historical reserve currency.
- Jon Huntsman Will Leave Republican Presidential Race, Endorse Mitt Romney, Officials Say (WaPo)
- Dont laugh - Plosser: Fed Tightening Possible Before Mid-2013 (WSJ)
- Greece’s Creditors Seek End To Deadlock (FT)
- France Can Overcome Crisis With Reforms – Sarkozy (Reuters)
- Nowotny Says S&P Favors Fed’s Bond Buying Over ECB’s ‘Restrictive’ Policy (Bloomberg)
- Bomb material found in Thailand after terror warnings (Reuters)
- Ma Victory Seen Boosting Taiwan Markets as Baer Considers Upgrading Stocks (Bloomberg)
- Japan Key Orders Jump; Policymakers Fret over Euro (Reuters)
- Renminbi Deal Aims to Boost City Trade (FT)
In keeping with the theme of everything decoupling from everything else these days, a comparable decoupling pattern could be observed in China's December trade data, which experienced a surprising jump in its trade surplus from $14.5 billion in November to $16.5 billion in December, even if exports broadly slowed down and grew at the slowest pace in 10 months. This number was quite odd as it represents almost double the consensus forecast $8.8 billion, predicated by a matched slow down in imports which were up only 11.8% Y/Y, the smallest rise since the October 2009 decline of 6.4%. The odd jump in the trade surplus appeared at a time when many were expecting that the slowing Chinese economy would be well on its way to shifting from surplus to deficit, leading to a devaluation of the CNY (as opposed to the constant badgering form the US and Chuck Schumer demanding a revaluation of the renminbi). Furthermore, as the year winds down to the Chinese Near Year in February, this has been a traditional time when Chinese surpluses decline and go negative, even in good years (see 2010 and 2011). Yet a quick glance at China's two primary trading partners: the US and EU does not reveal anything peculiar: both were either flat or saw just a modest drop in the trade surplus - good news for anyone concerned if the European slowdown would hit the country's largest trading partner. Which is where the decoupling occurred, as the surplus soared in the "rest of the world" or the non-EU/US category. As can be seen below, December is traditionally a month when the surplus contracts and approaches the flatline. Yet this year, oddly enough, the December surplus doubled from $5.8 billion to $11.4 billion. Just who is it, outside of the US and EU, that suddenly saw a pressing need for Chinese imports?And yet all of the above is likely just minutae when one considers something far more important: Chinese Oil imports. As the chart below shows, sooner or later excess capacity within the OPEC system is going to disappear. And then it gets really interesting.
- Obituary: Kim Jong-il (FT)
- Draghi Warns on Eurozone Break-up (FT)
- EU Ministers Seek Crisis IMF Funding Deal (Bloomberg)
- China November Home Prices Post Worse Performance This Year (Bloomberg)
- China Debts Dwarf Official Data With Too-Big-to-Finish Alarm (Bloomberg)
- China opens up to offshore renminbi investors (FT)
- Voters to Read Recovery Signs (Hilsenrath)
- Germany May Pay Full ESM Contribution in 2012 (Reuters)
- U.S. Housing Heals Even as its Damage Widens (Reuters)
- S&P Cut Proves Absurd as Investors Prefer U.S. (Bloomberg)
For today's humorous detour, we go back in time, some could say to prehistoric days, and pull the 2011 year end predictions by Blackstone's grizzled (date of birth Valentine's Day, 1933) Vice Chairman Byron Wien posited back on January 1, who for 26 years in a row tries to predict the future. And fails. Well, technically he did get gold right. And yes, there are two more weeks left in 2011: Wien may still be proven right... crazier things have happened.
Bloomberg headlines confirm the Chinese export-led growth dynamo is growing dimmer by the day:
- CHINA'S `NOT TOO OPTIMISTIC' ABOUT EXPORTS IN 2012, CHEN SAYS
- CHINA'S TRADE GROWTH MARGIN DECLINED IN DECEMBER, CHEN SAYS
- CHINA EXPORTS 2 PERCENTAGE POINTS LOWER IN EACH MONTH OF 4Q
- CHINA 2011 IMPORT GROWTH RATE 5 PCT POINTS HIGHER THAN EXPORTS
- CHINESE COMMERCE MINISTER CHEN DEMING SPEAKS AT GENEVA BRIEFING
Translation: the next several Chinese monthly surplus reports will not be pretty, and even more importantly, The Chinese trade defict, as predicted by Albert Edwards some time ago, is finally coming (read here, here and here). Lastly, it means the CNY is about to reverse: expect Congress to go nuts once China undergoes several weeks in a row of Renminbi devaluation. The trade war that will follow should be quite epic.
Every year since 2005, more than 50% of China's GDP has consisted of construction-related spending. The law of diminishing marginal returns says this simply cannot continue. It represents a misallocation of the household sector's hard-earned savings on a colossal scale, and I believe it will end badly. Not a day goes by that there aren't riots and protests somewhere in China (including cyberspace) as the downtrodden man in the street reaches his froggy boiling point. Increasingly in China, though, those who see the writing on the wall can see that the days of system stability are numbered. And they're not hanging around.
While Draghi somewhat shut the door on the ECB being the lender of last resort today, there appears to be a sucker-of-last-resort where Dim Sum bonds (offshore/HK Yuan-denominated bonds) have seen issuance almost triple in the first 11 months of the year. The WSJ is reporting that 76 entities issued CNY99.1bn YTD, according to the Hong Kong Monetary Authority. Interestingly, the biggest growth in the second half of the year has been from European firms who are unable to raise funds economically due to the crisis of confidence at home. Bloomberg notes BMW and Lloyds as two recent issuers with the latter managing to price CNY-denominated 3Y debt at 3.6% yield against comparable EUR-denominated debt at 5.3% - quite a saving if you're willing to take the currency risk (or looking for non-Euro, non-USD diversification) as a corporate Treasurer (or desperate for the money). But for the bulk of Chinese issuers it would seem evident that the Dim Sum investors are perhaps a little too eager to be lending their Yuan, and therefore not being appropriately compensated for credit risk concerns (even with the implicit FX revaluation bet).
This fear is even more prescient when, according to Bloomberg, one considers that 60% of Asia's fastest growing bond market lack any of the standard leverage covenant restrictions (protection) that Western bondholders are used to. And just to add some more fuel to the rising yield fire of these bonds, Bloomberg just reported that eager bondholders are more than willing (and blind to the risks) to accept one-off payments from issuers in order to accept significant covenant concessions (completely disregarding the credit risks through time). Our Dim Sum index has seen average yields jump a significant 70bps to 3.31% since mid-September leading us to raise concerns that this market, on which ETFs are now being created, is worryingly exposed to both a systemic Chinese credit crunch and idiosyncratic releveraging even if managers view Dim Sum as more of a currency play.