Broke Down Engine?

"Feel like a broke down engine, aint got no driving wheel"
 -Blind Willie McTell
 
The World Bank's annual Global Development Finance report issued yesterday provided a grim assessment of the near term situation including estimates of a 2.9% decline in global output, a 10% contraction in world trade and a projected decline in private capital flows from $707 billion last year to $363 billion for 2009.  It wasn't the bad news in the report for this year that really spooked investors however, but rather the diminished expectations for recovery in 2010 -with a new global GDP growth forecast of just 2% and a predicted contraction for the developing world, excluding China and India. In short, the World Bank's annual report failed to identify any catalyst that could drive growth rates to pre-crisis levels over the next 24 months. Not a "V" recovery on the horizon, not even a "W" recovery, just a great big capital L for the next several years.
 
For our portfolio, yesterday was an unwelcome stress test as our commodity, energy and international long positions were pummeled by waves of selling. Yesterday's broad market action felt like an inflection point when short term consensus shifted focus from inflationary to deflationary concerns and the safety trade returned in a concentrated form: with treasuries and the Dollar as the only safe haven left for the timid.
 
While the market reaction to the World Bank's conclusions caught us off guard, we expected their argument. With conservative estimates drawn from rear view mirror observations, the data they released was hard to challenge but their conclusions were not. We are not joining this dash for the exits trying to stay ahead of a cyclical asset class shift, but rather are remaining firm in our convictions that the fundamental facts have not changed, and are as comfortable with our strategic convictions now as we were in January -before the 60% and 30% rise in the Shanghai Composite and the Bovespa respectively made our Q1 call consensus.  
 
Chinese data continues to support our thesis. With Q1 GDP still registering above 6% growth, Industrial production levels rising back towards double digits, imports of base metals and coal showing resilience,  new ground breaking daily on infrastructure projects and domestic consumption for durable goods from cars to laptops -Chinese internal demand measures continue to expand across the board. This weekend Premier Jiabao pledged to continue to pump more liquidity into the system, showing that Beijing continues to be willing to put their money where their mouth is and take risks to drive internal demand expansion.  
 
A fresh report released by the National Bureau of Statistics, written by Guo Tongxin, even tackles the omnipresent concerns over Chinese data quality, presenting greater transparency of the inner workings of Beijing's accounting process -not a fix by a long shot, but a promising start.  And, by the way, while the Chinese may make up their numbers, so do we!
 
Make no mistake: Chinese demand can't save the whole world on its own, but like the proverbial butterfly wings that drive hurricanes a thousand miles away, demand from "The Client" continues to be felt throughout the global supply chain.
 
Not that we dismissed all of the World Bank's conclusions entirely. The argument for a longer recovery period for weaker emerging economies seemed spot on to us -as long time readers know we have never bought into the emerging markets craze and have remained skeptical of the prophets of profit who espouse "frontier economies" from Ghana to Kazakhstan.
 
We diverge from their thesis on demand from the "developed portion of the developing world" if you will. As such, we continue to see growth prospects that can jump start global demand in the major Asian economies ex-Japan, combined with the smaller markets that stretch along the supply chain connecting them all the way back to commodity producers like Australia -which has thus far managed to avoid recession, and Brazil -which although challenged by commodity dependence continues to navigate the choppy waters with pragmatic leaders and significant room for policy loosening.  Furthermore, since all of this will occur inside a central bank sponsored free money vacuum, we expect this resurgent demand will drive inflationary pockets inside the global commodity matrix and drive rates higher ahead of policy shifts during the fourth quarter of this year.
 
As such, we won't be anchoring on one report from the World Bank. While our longs hurt us yesterday, our shorts made us money and we have better things to do than sit and sing the blues.
 
Andrew Barber
Director


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