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Five Shocks that Push Investors Off Balance

Marc To Market's picture




 

Archimedes said that if he had a lever long enough and a place to put his feet, he could move the world. Investors have access to incredible pools of capital and can lever immensely. They thought they had some place to put their feet. 

The foothold was made of several planks. The unorthodox monetary experiment and large deficit were inflationary. The debasement of paper money among the high income countries would boost the price of gold and spur flows into the emerging markets.

If the large deficits were not brought under control, interest rates would rise and growth would slow. Japanese investors, in particular, would respond to the return of the previous Liberal Democrat strategy, now on put on steroids, by protecting their savings by sending it abroad.

Intuitively these all made sense and perfectly consistent with neo-liberal orthodoxy and, ironically, perfectly consistent with the ordo-liberalism which has come to dominate the euro area (if not the EU) through Germany's influence. Yet, over the past week or so each one these planks has been shaken. Individually, it might not be a big deal, but collectively, it is shaken investors and economists and may impact policy, going forward.

With the exception of the UK, measured inflation in the high income countries is falling not rising.  Japan, Switzerland, and Greece have deflation.  The US and the euro area are seeing CPI slip further below 2%.  Last month, Sweden said its consumer prices in February showed no change on a year-over-year basis.  Last week, Canada report its consumer prices have risen 1% in the year through March. 

China, the world's second largest economy, recently reported that its non-food inflation is up less in the past 12 months (1.8% in March).  Other emerging market countries are facing greater challenges, including Russia and Brazil, where the central bank hiked rates last week.  India's consumer prices increases may have peaked, but remain high.  

It is difficult to find much evidence for assertions seen from time to time that easy monetary policy among the high income countries is effectively exporting inflation to low and middle income countries. The channel of transmission is understood to be the capital markets.  Yet capital flows into the emerging markets has been trending lower and, while the major equity markets have rallied to new record highs, as in the US, or multi-year highs as in Europe and Japan, the emerging markets have under-performed.  The MSCI Emerging Market Index is 14% below the 2011 high and is currently at five month lows.  

Rather linking this under-performance to QE, a more compelling narrative is more grounded in  specific developments, such as the Apple product cycle and pressure on the supply chain, largely in Asia.  Weaker Chinese growth is another source of specific and local pressure.  The decline in commodity prices has taken a toll on equities in many emerging markets, including Russia, Brazil and South Africa. 

The CRB Index has fallen nearly 9% over the past three months.  Copper has shed a fifth of its price seen in early February, which as an industrial metal may be saying something about Chinese demand.  However, it is the dramatic drop in the precious metals, and especially gold, that has shaken the ideological belief system of many investors.   

Gold's recent precipitous drop did not come from record highs set last year as the Fed launched an open-end program of long-term asset purchases and then doubled it at the end of the year.  Nor was the recent sell-off from highs set when the ECB unveiled a program of Outright Market Transactions last summer; nor when an Abe victory first seemed likely in Japan in middle of Q4 12.  No, gold's record high was set in September 2011 and it is now down about 30% from the high water mark.  And despite the neo-liberal rhetoric and analyses, many investment houses are suggesting the price of gold has peaked.  

Just like we did not read much into gold's ascent, we do not read much into its descent.  If analyzed as any other commodity, stripped of the magical powers often attributed to it, what happened to gold is understandable.  Three events took place that spurred the sell-off.  First, was a violent short-covering of the yen in the foreign exchange market.  The yen had been used as a financing currency over the past several months to fund other investments, including gold.  The unwinding of this carry trade hit a vulnerable market.  

Around the same time, it became clear that countries in Europe seeking aid would be under more pressure to raise funds through asset sales.  Those assets are not only commercial in nature, but also include the gold reserves.  The 10 tonnes of gold Cyprus may sell is a relatively modest about for the gold market, with a value of about 400 mln euros.  It is also a relatively small amount relative to the size of the Cypriot contribution to its assistance program of now estimated around 26 bln euros.  However, the gold holdings of other periphery countries and assumed to be a new source of overhead supply.  

Lastly, the performance of competitive assets, like equities, in a low inflation environment, and slowing growth, also seemed to reduce the conviction that gold was where to be now.  As it has done for the past couple of years, the US economy is appears to be slowing markedly in early spring.  Europe continues to contract.  China's growth has downshifted.

In this context, the distinction between decline in paper claims on gold (futures and ETFs) and physical demand (gold bullion and coins) that some gold proponents have resorted to is not very helpful.  It is similar to contending that the drop in the corn futures is somehow less significant because consumers are still buying corn on the cob or cornflakes.  

The behavior of Japanese investors has also gone against the conventional view as well.  The  Bank of Japan's program that entails doubling of its asset purchases and the doubling of the average maturity of those purchases was going to force Japanese investors to export their savings to protect the value.   Contrary to the numerous claims that attributed the decline in European bond yields or the rally in some emerging market bonds to Japanese investors, the most authoritative data shows Japanese investors have continued to sell foreign bonds.  

In fact, the weekly Ministry of Finance data shows that Japanese investors have sold bonds every week this year, with three exceptions and two of those were in January.  The benchmark indices that many Japanese institutional investors use give only a small weighting to emerging markets.  

There is a clear preference for the liquidity and safety of core bond markets in the North America and Europe.  The investment proposition does not seem particularly attractive as these bond offer near-record low yields and the quality is suspect, as the downgrade of the UK's credit rating by Fitch (following Moody's move last month) illustrates.  

Japanese insurance companies and pensions do seem likely to boost their foreign allocation in the coming weeks as the FY13 plans are implemented.  However, the combination of a weak yen and strong foreign asset prices may also encourage some investors to book profits on the large stock of foreign investments that have been accumulated.  Moreover, as the recent data indicates, the foreign appetite for Japanese shares remains strong.  The latest weekly report showed record foreign buying of Japanese stocks 

The questions raised over the Rogoff-Reinhart work have also shaken the neo-liberal and ordo-liberal analyses and prescriptions.  The first response by the ideologues is that the critique raises narrow issues, such as is 90% debt/GDP a tipping point, not the general and important claim that high levels of debt cause coincide with weak growth.  

Even though the austerians in the US and Europe frequently cited Rogoff and Reinhart's work to support their agenda, it did not create the agenda in the first place.  Nor will any criticism of their work negate the contention that one cannot solve a debt crisis through the creation of more debt.   

Nevertheless, just like Rogoff and Reinhart's essay "Growth in the Time of Debt" (2010) and their book "This Time is Different:  Eight Centuries of Financial Folly" was a touchstone austerians, the critique of the work is part of the coalescing push-back.   Recall that over the past year, the IMF, which previously seemed to act as that its acronym really did stand for Its Mostly Fiscal, has 1) admitted that it had under-estimated the fiscal multiplier, or how much tightening of fiscal policy would have on the overall economy, and 2) urged some countries to balance the austerity efforts with growth measures, and 3) has been increasingly critical of the UK's austerity drive.  

In the euro area, the EU is conceding extensions to several countries that are over-shooting this year's deficit targets.  Several members have simply refused to enact any more spending cuts or tax increases.   In Japan, Abenomics is not simply about monetary policy, but it also includes more fiscal stimulus, even though debt/GDP stands near 230%.  

Ironically, the austerians have moved into ascendancy in the US.  The fiscal drag from the US this year will be greater than from Europe.  Indeed, the deficit is falling faster than many expected and this is prompting economists to lower their forecasts for the current fiscal year.  

Half way through the fiscal year and revenues are greater than expected  and expenditures less than anticipated.  The nominal growth rate in spending is the lowest in decades.  Revenues are up 12%  in the current fiscal year.  This means that the full year deficit may come in below 5% of GDP.  It is not just a function of the end of the payroll tax holiday as revenue was increasing prior to January 1. Similarly the spending decline preceeded the sequester.  Making some conservative assumptions, it is possible the US budget deficit fall below 3% (of GDP) in FY15, which may be before this is achieved by many euro area members.  

In any event, the point Rogoff and Rinehart's works was not ideologically neutral and the criticism of also has ideological implications.  The key issue is not really over tipping points or even broader methodological questions, but over the causal narrative that is told (including in speeches and essays by Rogoff and Rinehart) between high debt and slow growth.  As many, including ourselves, noted, the causal arrow often seems the reverse; that slow growth creates larger debt burdens.  Stronger growth in the US (than Europe) is one of the reasons why the US deficit is falling quicker.  

It may take some time for investors to regain their balance after being discombobulated by recent events.    Neo-liberalism and ordo-liberalism have a flexibility that is often under-appreciated.  Nor should our ability to manage cognitive dissonance be under-estimated.  Nevertheless, the foothold for investors and policy makers seem less secure than before. 

 

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Sun, 04/21/2013 - 20:39 | 3481892 WhiteNight123129
WhiteNight123129's picture

Do not confuse nominal with real, and the unfunded liabilities are omitted Marc.

Finally, the government deficit is not an issue in abstraction or without a context. We have too much debt to GDP = Financial assets (debts and  equities) are overvalued in relation to present goods of the circulation i.e. GDP. Gold is also undiscounted and a present good.

Period.

 

Sun, 04/21/2013 - 20:31 | 3481872 bardot63
bardot63's picture

Say what?  Not even a nice try.  Thumbs down.

Sun, 04/21/2013 - 18:23 | 3481491 akak
akak's picture

I gave this article a rating a "1", only because there was no option to give it a "0", due to Marc's idiotic and insulting implication that government CPI statistics bear any relationship to reality.

Sun, 04/21/2013 - 18:55 | 3481581 Marc To Market
Marc To Market's picture

Really Akak, I write a piece on the five things that have surprising investors and you want to quibble over one...that government CPI statistics bear any relationship to reality ?  Really, is that the best you got?   That is not an argument.  When you construct a better measure, let the world know, please.  

Sun, 04/21/2013 - 20:21 | 3481830 akak
akak's picture

Marc, the fact that you implicitly accept the bogus and insultingly lowballed CPI statistics as even a halfway honest or accurate measure of currency debasement ("inflation") says volumes about your credibility and intellectual honesty and independence --- or more precisely, your lack of all those qualities.

By repeating official if ridiculous propaganda and lies, you prove yourself nothing but a hack and a co-opted lackey for a corrupt and failing status-quo power structure.  You cowed and servile Quislings are a dime a dozen, and I fail to see what value Tyler might see in bringing you and your bilge here except perhaps to serve as a lightning rod for righteous indignation.

Sun, 04/21/2013 - 20:30 | 3481864 tip e. canoe
tip e. canoe's picture

at least he's got the cajones to come to the comment section.

Sun, 04/21/2013 - 20:37 | 3481889 fonzannoon
fonzannoon's picture

I appreciate anyone that does.

Sun, 04/21/2013 - 20:19 | 3481829 fonzannoon
fonzannoon's picture

Marc how come when gold bulls/owners... whatever... claim that physical bullion sales being extremely strong support the case for gold, they are just "resorting" to some weak claim but when Larry Kudlow and company spend 55 minutes of every hour slamming me with the idea that someone dumping 400 million ounces or whatever it was on the market in one transaction, that is natural and a good thing and establishes that gold is no longer a viable asset class?

When the housing market crashed I remember the MSM blasting me over and over again that I needed to buy asap but they never seemed to show that their was any physical home sales to support their argument, same thing for stocks.

Sun, 04/21/2013 - 19:55 | 3481754 suteibu
suteibu's picture

In a less complex system, there is no need to measure it at all.   It does not benefit the population, only politicians, bureaucrats, and traders.  Complexity is a feature only for the same crowd and has led to the financialization of the world's economy which is not, I would argue, a long-term positive situation.

 "If you can't explain it to a six year old, you don't understand it yourself." - A. Einstein

Mon, 04/22/2013 - 01:17 | 3482670 bluskyes
bluskyes's picture

+1 suteibu.

Government statistics are meant to serve as a panacea, a sedative if you will. It's only purpose is to lull the public into complacency regarding public matters, and to assure them that "there's nothing to see here" go back to sleep. The government has everything well under control.

 

Sun, 04/21/2013 - 17:38 | 3481368 fonzannoon
fonzannoon's picture

I read elsewhere that Marc does not believe that the US exports inflation. Correct me if I am wrong Marc.

Sun, 04/21/2013 - 18:51 | 3481570 Marc To Market
Marc To Market's picture

Exactly where is the US exporting inflation and what is the channel of transmission ?  If the channel is trade, most of the major US trading partners have low falling measured inflation.  If it is capital flows from the US, the US is a net importer of capital.  It is true that China's food inflation is well above its non-food inflation.  It is not clear to me how this is food inflation is caused by the US monetary policy.  Global capital flows to the emerging markets has fallen, not increased over the last couple of years.  Emerging market equities are underperforming the equity markets among the high income countries.    

 

 

 

 

Sun, 04/21/2013 - 20:46 | 3481908 bardot63
bardot63's picture

Here's how you measure inflation. You go to the supermarket and bacon is now a 12-ounce pound and costs twice what it did last year.  You find apples at 2.49 a pound, putting a nice apple at a buck.  You need a new roof, and find the best estimate is twice what you paid 10 years ago.  You spend 1.50 on a can of tuna that cost 50 cents 8 months ago and didn't have Fukishima in it.  Cheap wine is now $8, not the $1.50 you paid for Boone's Farm in college.  Your savings account now makes .002% interest, until of course the gov't Cypruses you, and Uncle Sam tells you inflation is not showing up.   Come on, Dipwad, get real in a real world.   

 

Sun, 04/21/2013 - 19:32 | 3481695 bluskyes
bluskyes's picture

Doesn't the US export inflation when selling it's bonds overseas, while the Fed is also bidding, and keeping the yield down to near zero? Does this not keep the yield below the true rate of inflation as felt by the American consumer?

Sun, 04/21/2013 - 17:34 | 3481357 LawsofPhysics
LawsofPhysics's picture

Another piece of crap piece from "Marc to fantasy". CPI is bullshit. Let's see, what are my fuel, input costs, insurance costs and health care costs now, compared to 5, 10, or 15 years ago. Gold is a store of value, period. Look at it's value in priced in fiat over the same time period. Garbage, another propaganda shill.

Sun, 04/21/2013 - 18:56 | 3481585 Marc To Market
Marc To Market's picture

Great gold is a store of value and the price just collapsed.   Does that tell us inflation is a problem ?  

Sun, 04/21/2013 - 20:51 | 3481957 LawsofPhysics
LawsofPhysics's picture

The price collapsed? LMFAO? What was the price 5, 10, or even 15 years ago dipshit? Try again loser.

Sun, 04/21/2013 - 18:14 | 3481465 mind_imminst
mind_imminst's picture

Agreed! CPI is not relevant to "the people". CPI (and international inflation stats) is the measure of inflation which is important for money center banks an central banks.

Inflation for the masses is rampant. Food inflation is constant where I live. Gas remains very high. Natural gas is increasing. Government fees and taxes hve gone up. Health care costs are going up. Education inflation is way out of control. Marc needs to look beyond the CPI to see how regular people are getting crushed by inflation.

Sun, 04/21/2013 - 19:01 | 3481599 Marc To Market
Marc To Market's picture

mind_imminist--do you appreciate the difference between a relative price increase and a general price increase.   Do you appreciate that an increase in fees and taxes is is deflationary insofar as people have less disposable income to spend on other things/services?   Do you know that low measured inflation does not preclude that fact that some prices are rising and rising sharply.  Do you understand the government's methodology for calculating consumer prices and do you appreciate the differences between the CPI and PCE deflator ?  

Sun, 04/21/2013 - 19:47 | 3481745 suteibu
suteibu's picture

Do you understand that whether prices go up because of inflation or taxes and fees go up, the effect is the same for the consumer class (read: demand)?  They have less purchasing power which leads to slow (no) growth and deflation.  When the basket of goods used to calculate the CPI  does not reflect what people actually spend most of their money on, the whole concept of tracking inflation/deflation is suspect and considered political manipulation (changing the CPI to affect cost-of-living-increases for redistributive programs in order to "save the system" or, better put, admission of failure and abrogation of promises made to the public by the government).

What you are witnessing by the previous comments is the loss of faith in the data and those who produce it, the first step in the ultimate collapse of confidence in government and the economy.  Sometimes the people who are the economy (who just happen not to be the people who manipulate the economy) are treated like they don't matter when the truth is, there is no economy without them no matter how much central bankers print or how high the markets go.

Sun, 04/21/2013 - 19:37 | 3481708 bluskyes
bluskyes's picture

Are increases in fees, and taxes included in the CPI? Isn't a rising fee/tax relative to a static service inflationary? IE higher price  today for the same service provided at a lower price yesterday?

Sun, 04/21/2013 - 15:19 | 3480942 BlueCheeseBandit
BlueCheeseBandit's picture

"In this context, the distinction between decline in paper claims on gold (futures and ETFs) and physical demand (gold bullion and coins) that some gold proponents have resorted to is not very helpful. It is similar to contending that the drop in the corn futures is somehow less significant because consumers are still buying corn on the cob or cornflakes. "

That's the most specious comparison I've ever seen.

If the price of a commodity falls, demand increases, because people can consume it for less.

But the people buying gold and silver after this drop are buying it for investment purposes.

If a currency drops significantly and people start buying like crazy, the logical conclusion is that it's undervalued, not that people are using the opportunity to buy little pieces of paper to enjoy them for their own sake.

I'm just glad I got my order in on Tuesday, because gold is back over 1400 and silver is sold out.

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