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TWO SCHOOLS OF THOUGHT PART II

CONCLUSION: We continue to view a sustained breakout in the USD as the most asymmetric and contrarian outcome facing global financial markets over the long-term TAIL.

 

RELATED THEME(S): The Last War: Fed Fighting; Asymmetric Risks

 

Last AUG, we published a note juxtaposing the ideology of the Reserve Bank of Australia’s Glenn Stevens with that of our very own Ben Bernanke titled, “TWO SCHOOLS OF THOUGHT”. The conclusion of that piece read: “Call us dogmatic, but we continue to stand by our belief that currency debasement in the form of deficit spending, debt buildup, and Indefinitely Dovish monetary policy is not supportive of the long-term prosperity of America.” We reiterate that view.

 

Overnight, we received additional commentary from Governor Stevens that further sheds light upon the asymmetric setup in US monetary policy: 

  • “The intended effect of recent policy actions [-125bps of cuts] is certainly not to pump up speculative demand for assets. Our judgment is that the risk of re-igniting a boom in borrowing and prices is not very high, and this was a key consideration in decisions to lower interest rates over the past eight months.”
  • “One thing we should not do, in my judgment, is to try to engineer a return to the [pre-2008] boom. Many people say that we need more ‘confidence’ in the economy among both households and businesses. We do, but it has to be the right sort of confidence.”
  • The central bank shouldn’t neglect retirees and others who live on income from their savings. Popular discussion of interest rates routinely ignores this element, focusing almost exclusively on the minority of the population -- just over one-third -- who occupy a dwelling they have mortgaged.” 

We continue to believe that policy drives currencies. Moreover, we continue to view a sustained breakout in the USD as the most asymmetric and contrarian outcome facing global financial markets over the long-term TAIL – an event that becomes increasingly probable if the currency market believes that US monetary and fiscal policy will become sustainably more hawkish on the margin.

 

As Keith penned in his Early Look yesterday, the US Federal Reserve has overseen the buildup and rapid unwind of three massive bubbles over the past ~15yrs (tech, housing, and commodities). What if US monetary and fiscal policy becomes more about avoiding bubbles (for the sake of sustainable growth), rather than trying to engineer a return to their peaks?

 

In light of that question, here are a few more key questions for you to ponder over the long-term: 

  • Central banks and sovereign wealth funds have been diversifying away from dollars for a reason (namely its value has been forced lower by US policymakers for 10+ years)? What happens when dovish US policy or policymakers is/are replaced?
  • What happens if said actors increasingly believe that the EUR and the JPY are less credible stores of long-term value?
  • In the event of a TAIL-duration Strong Dollar trend, what becomes of the natural resource and CapEx fueled growth booms across the emerging market space from both a economic and capital markets perspective? EM stocks/bonds/FX are all asset classes with heightened risk in this scenario (think: Asian Financial Crisis, Russian and Argentinean sovereign defaults, etc.). 

Net-net-net, we’d be lying if we said we knew exactly how the next 3+ years of investing was going to play out. At a bare minimum, however, investors should be pondering these types of off-the-radar questions and perhaps buying inexpensive L/T insurance when and where they can find it.

 

Have a great weekend,

 

Darius Dale

Senior Analyst

 

TWO SCHOOLS OF THOUGHT PART II - 1

 

TWO SCHOOLS OF THOUGHT PART II - 2


THE M3: GENTING TAKES STAKE IN ECHO; SANDS BEIJING PAYMENT; PAGCOR

The Macau Metro Monitor, June 8, 2012

 

 

GENTING TAKES STAKE IN AUSTRALIA'S ECHO, SPARKS TAKEOVER TALK The Australian, Reuters

According to the Australian, Genting Singapore has taken a 4.9% stake in Echo.  Echo runs Sydney's Star casino and Jupiter's on the Gold Coast of Australia.  This raises the prospect of a battle for control over the $3 billion Australian casino company with billionaire rival James Packer.  Packer, who wants to use Echo's license to build a new casino complex in Sydney to attract more Asian high-rollers, has been agitating for change at Echo after building a 10% stake in the company.  Genting said the total value of its investment in publicly quoted securities was S$298 million (US$234 million).

 

Also, Echo's Chairman, John Story, has resigned, bowing to a destabilizing campaign run by Packer.  A full takeover would cost more than A$3 billion (US$2.96 billion) and both Packer and Genting would face tough regulatory scrutiny.

 

SANDS SOLICITED FOR PAYMENTS BY BEIJING OFFICIAL WSJ

Leonel Alves, an outside legal adviser to LVS with political connections in China and Macau, said in emails he was approached by “someone high ranking in Beijing” to pay $300 million to settle a lawsuit and win long-awaited approval to sell a luxury-apartment complex in Macau.  The Journal, which reviewed the emails from late 2009, reported that LVS, which was reeling from the financial crisis and under a mountain of debt, was looking for a way to sell a complex it valued at $1.4 billion but in an area only designated for casino and hotel projects.  That designation meant a sale would require government approval.

 

LVS said in a statement that “at no time has there ever been any suggestion that the company made any improper payments or received any improper benefits.”  Alves, responding to the Journal by text message, said any claims that he suggested bribing government officials were “totally untrue,” and that “nothing had happened.”

 

PAGCOR PRIVATIZATION TO BENEFIT MACAU: COMPANY OFFICIALS Macau Business

State-owned gaming company and regulator Philippine Amusement and Gaming Corporation, or Pagcor, is facing a proposal to be privatised.  But company officials say that would lead to a loss of competitive edge for the country’s gaming industry, which would instead benefit Macau, Singapore, and Malaysia.


A bill to privatize Pagcor and instead create a new body with only regulatory powers has been filed in the Philippine Senate by pro-administration Senator Ralph Recto.  The bill also proposes a significant tax hike – casinos would be obliged to pay 5% in gross revenue tax plus an additional 50% tax on aggregate gross earnings.  Pagcor officials say the company currently only charges from 2 to 15% on gross gaming revenue for non-high roller gamers; 15% on high rollers and junket tables; and 25% on slot machines.


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The Plan

“We are comfortable missing out on potentially major rallies if they are based purely on money flows or government action; the risks of engaging in this sort of speculative activity are simply too high.”

-Seth Klarman

 

I’ve always enjoyed reading the quarterly letters and writings of great investors.  From my perspective, Baupost’s Seth Klarman fits into the category of a great investor.  The quote above is from his Q1 2012 letter to investors.  On some level, Klarman has earned the right to underperform in the short run as his long run track record, almost 30 years, is superior to almost any investor in that time frame.

 

That being said, I think what likely differentiates Klarman and many investors with superior long run track records is their process.  My guess is that Klarman may have written the above quote even just a couple of years into his career before his track record was established. 

 

The fact is great investors have a process.  Sometimes the process tells them to invest aggressively, sometimes it tells them to stay on the sidelines with large cash balances, but the outcome of the process is a plan to allocate capital.  Overtime, if the process is superior, the outcome will be positively differentiated returns.

 

If I were allocating capital to funds, the first question I would ask any potential manager would be - what is your process?  That would be followed by - why will this process produce superior results over time?  Undoubtedly after reviewing their historic results, I could determine whether they actually had a process and executed on their investment plan accordingly.  

 

The famed Spanish painter Pablo Picasso said this about having a plan:

 

“Our goals can only be reached through the vehicle of a plan, in which we must fervently believe, and upon which we must vigorously act. There is no other route to success.”

 

Quoting a famed European artist about planning is somewhat appropriate given the current debacle in Europe.   Now this isn’t a shot at Europeans but rather a shot at the lack of an actual long term plan emerging to solve Europe’s long run debt crisis. Not to mention, the lack of a long term plan when the common currency was established.

 

I’ve had a number of friends who are traders, either personally or for large institutions, email me over the last couple of days and the general consensus in the trading community seems to be that the market will remain choppy until after the Greek elections, the G20, the FOMC, and the EU Summit.  Not to put words in their mouths, but the plan in the trading community seems to be to not do much until the central planners are done planning.  I like that plan.

 

As we wait for the central planners to stop their planning, the economic data out of Europe continues to deteriorate.  The key European economic data from the last 24 hours includes:

  • German exports declining in April -1.2%, for the first decline this year (worse than expected);
  • Bank of France cuts its forecast in Q2 for France to -0.1% (worse than expected);
  • Italian industrial output for April comes in weaker at -1.9% month-over-month (worse than expected);
  • Netherlands April industrial production comes in at -2.7% month-over-month (weaker than expected); and
  • Greek GDP contracted -6.5% in Q1 from a year ago, versus the -6.2% projected decline on May 15th.

The most startling data point is likely the last one.  Not because the Greek economy matters all that much anymore, but rather because the Greek government continues to have a difficult time getting a handle on the actual data.  Personally, I’ve basically accepted that most governments make up the numbers, so revisions, either up or down, are really of no great surprise. 

 

Speaking of government data, the Chinese government will be releasing a broad swath of data over the next 24 hours, including consumer price index, industrial production, retail sales, and producer price index.  For many, the plan is to buy commodities and risk assets if a Chinese rate cutting cycle begins in earnest.  In the Chart of the Day, you can see why this may not be such a good plan, at least according to the last cycle.

 

Specifically, on September 16th, 2008, China cut rates for the first time in the cycle.  As might be expected the 19-commodity CRB index ripped +9.5% in six days.  By March 2nd, 2009, the CRB index bottomed -46.4% lower.  Chinese rate cutting may have been a panacea for some, though not for those investors levered long of commodities.  (Thanks to my colleague Darius Dale for putting this analysis together.)

 

Certainly, risk assets may act differently this time around if China starts to cut interest rates aggressively.  My point is simply that front running central planners, to Seth Klarman’s point above, is a dangerous plan, if it is a true investment plan at all. 

 

Yesterday, Chairman Bernanke presented his plan to Congress and as part of that testimony he said:

 

“The Committee reviews the size and composition of its securities holdings regularly and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”

 

This came at the end of the paragraph in which Bernanke outlined the Fed’s current actions, namely federal funds rate at zero for an extended period and a number of rounds of quantitative easing.  In effect, via error of omission perhaps, Bernanke insinuated yesterday that the Fed is basically out of bullets.   This might just be the best plan I’ve heard from the Federal Reserve in years.

 

Our key levels are: SPX fails at 1332 resistance (no support to 1283 TAIL); VIX holds 21.41 TRADE support, resistance = 24.73; USD holds all lines of support (range = 81.98-82.62); Euro fails, again, at 1.25 resist, support = 1.22; Oil (brent) fails at 101.73 TRADE resistance, no support to 95.26 (bearish formation there); and Gold has a big breakdown through our 1596 TRADE support, now nothing to 1538.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Plan - Chart of the Day

 

The Plan - Virtual Portfolio


Rumor This

This note was originally published at 8am on May 25, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“China, despite the slump of 2012-2013, has recovered its growth momentum and is economically dominant.”

-Arvind Subramanian

 

That’s my rumor this morning. Got one? How many more do we need from conflicted and compromised central planners of Keynesian states to keep this no-volume stock market ball in the air? This is really getting sad to watch.

 

Markets don’t lie; politicians do. The aforementioned quote isn’t a lie; it’s a potential long-term risk management scenario. Looking at our core Growth & Inflation macro model for China in 2013, it’s actually a very credible one.

 

The forecast comes from the introduction of a book I just started reading called “EclipseLiving In The Shadow of China’s Economic Dominance.” Since it was published by the Peterson Institute, at least some of the people sleeping in Washington right now have seen it. They don’t even have to read it. The cover is red and shows Obama bowing to Premier Wen.

 

Back to the Global Macro Grind

 

If I’ve written this 100x in the last 5 years, I’ve said it 1000x – if you lose the trust of The People, you will lose the mother’s milk of markets – inflows. The more markets depend on baseless rumors for intraday moves, the less inflows you are going to have.

 

Actually, never mind inflows – at this point what you should be really worried about as an asset manager are outflows. Some people are stupid with their money. Most people aren’t – at least not after you burn them 3, 4, or 5 times with the same thing.

 

Q: What is that thing? A: Growth.

 

If you don’t have growth, a government certainly can’t manufacture it. Remember Obama’s economic “advisors” (Christina Romer and Jared Bernstein) promising a government spending multiplier on $800B of 1.5x? Lol. Thank God they’re both gone.

 

What you need to do is what the #FairShare crowd can’t handle - let it slow. Then growth slows to a point from which it can recover. When Growth Slows at a slower rate, we start to think about getting long; really long (like we did in 2009).

 

When it comes to Chinese growth, genius observers of the last 2 years of reported news will tell you that it’s slower than where it was in 2009-2010. Newsflash: that’s why the Chinese stock market was down double digits for each of the last 2 years. Markets discount future expectations.

 

Today, we’re trying to measure the slope of Chinese growth (we model the same for 86 countries in our model) and when it’s most likely to slow at a slower rate. When running our predictive tracking algorithms, we consider Growth & Inflation on all 3 of our risk management durations:

  1. TRADE (3 weeks or less) = we see Chinese growth slowing at an ACCELERATING rate
  2. TREND (3 months or more) = we see Chinese growth slowing at a SLOWER rate
  3. TAIL (3 years or less) = we see Chinese growth re-ACCELERATING at some point in 2013-2014

We use real-time market signals and high-frequency economic data to make risk managed research statements. We don’t take a survey or tell you how Chinese growth “feels.” The only feel I can give you about Global Growth Expectations right now is that they still feel heavy. And they will until Hatzius and Hyman cut their growth estimates to where the growth data currently resides.

 

Q: What’s the only way out of this thing? A: Strong Dollar.

 

That’s the only thing that will Deflate The Inflation of commodity prices. That’s the only thing that matters, on the margin, to the 71% of US Consumption growth that drives US GDP. That’s also the biggest thing that will allow China to cut rates, aggressively.

 

So instead of begging for bailouts and whatever other rumor some Keynesian can concoct in the next 4 hours of trading, let’s keep pressuring the political elite to get out of the way. Out with the academic dogma, we want our Dollar back.

 

With the US Dollar Index up for 4 consecutive weeks, it’s working.

  1. American Purchasing Power (USD) is up +4%
  2. Oil prices are down -15%
  3. US Consumer Discretionary stocks (XLY) are now the best performing Sector in the S&P 500 (+11.1% YTD)

Get the Dollar right, and you’ll get America right. If we don’t, by 2013 we’ll be stranded on an island of hopeless growth like Japan and Europe are, begging for the Chinese to bail us out.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1533-1565, $104.48-108.43, $81.53-82.61, $1.25-1.27, and 1294-1342, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Rumor This - Chart

 

Rumor This - vvvvvp


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