some macro pitches

Long Mexico (EWW)

·          It's sold off hugely due to oil (it's an oil producer), but it's overdone since the government fully hedges its oil exposure (rumors are that the gov't sold futures near $100, basically locking in that price for its oil sales for the medium term). This should preserve gov't finances for this year at least.

·          In the long term, as Chinese labor gets richer and therefore costlier, more manufacturing should localize and move to Mexico to take advantage of its cheaper labor force (a MX auto worker cost 20% of his American equivalent) and its infrastructure and trade ties with the US and the rest of the world (Mexico has the most FTA free trade agreements in the world after Israel).

·          Thus it's levered to the strong US recovery, albeit with a lag.

·          Capital inflows and foreign investment are growing, with Mexico privatizing and selling off its oil assets for the first time in decades (auction results have been a bit disappointing however, need to watch this closely).

·          Auto manufacturers have announced plans to start plants in Mexico (including German car co's such as VW, BMW, Mercedes and Japanese car co's like Toyota, Honda, Nissan). This will also be supportive for the currency, which has been a victim of the indiscriminate Latam selloff since oil prices fell late last year.

·          MXN been used a liquidity proxy as one of the most liquid EM FX and has deviated too much from fundamentals. Lower cost of carry vs. other FX like BRL.

 

Short Brazil (BZF)

·          Perfect storm of several factors: stagflation (recession at the same time as high inflation of 9.5% vs. 4.5% target), too much debt/deficit yet they're at a bureaucratic impasse to pass budgetary austerity measures, no political support and significant political uncertainty, BCB is conflicted and already has very high rates (raising would mean deeper recession but less inflation and stronger currency), BoP deficit and choice of impossible trinity trade-offs means weakening FX, CB FX swap interventions are ineffectual

·          Classic case of Dutch Disease, in which a country's over-reliance on natural resources creates upward pressure on its domestic currency, reducing the attractiveness of the country's exports from other sectors, such as manufacturing. This creates a feedback loop in which non-resource sectors fail to attract investment or jobs, and the country becomes even more reliant on natural resource exports. For the past decade, however, the commodity price boom has hugely beneficial for those who have depended on its high prices for economic prosperity. However, like all good things, the commodity super-cycle has come to an end.

·          Many countries have dealt with Dutch Disease by nationalizing and saving its export revenues, usually through a sovereign wealth fund. This is not something that Latin America has done, however. Unfortunately, much of the wealth from these export surpluses were squandered through gov't handouts rather than investment and infrastructure.

·          The result is textbook reforms: this will be a painful adjustment to better fit reality: they need to be able to provide value-added goods and services and not rely on nat resources. 

·          Political realities are tough: President Dilma might get impeached, FM Levy can't pass a budget, 90% budget is non-discretionary

 

Long China/Asia (ASHR, GXC, GMF, AAXJ)

·          China is becoming more regionally active. Carrot and stick, China has a lot of carrots. Unlike the US, China is extremely pragmatic and morally agnostic, having no qualms with working with Muslim or authoritarian states if they have something that China wants. Willing to spend and invest huge sums, exceeding US foreign aid.

·          $100bn Asian Infrastructure Investment Bank (AIIB) is China's vision of a "new world order" led by Asia with China on top. This would supersede the post-Bretton Woods status quo of US-led IMF/World Bank/ADB/TPP international financial system. This could channel $20bn/yr of foreign investment into Asia, which would boost GDP, equities and currencies. Prominent proponents include Larry Summers and Hank Paulson have criticized the administration's stance towards AIIB, which many US allies have joined. Bernanke says it's because the US blocked a 2010 IMF agreement to shift 6% of quota/voting rights to EM.

·          CNY is now fairly valued. Bernanke emphasized that AIIB and CNY internationalization is mostly a symbolic and nationalist prestige issue rather than having any large practical economic implications.

·          For example, China-Pakistan Economic Corridor (CPEC): part of the Silk Road. It's a series of 50 projects totalling $46bn to connect Gwadar Port in Balochistan, Pakistan with Xinjiang, China. This creates a new, direct route for China to import oil from the Arabian Sea, bypasses the current much longer and less secure route which requires ships to pass through the Indian Ocean, the Strait of Malacca and the South China Sea, which are all geopolitical hotspots for China.

·          ASEAN-China Free Trade Area (ACFTA) - largest FTA in the world in terms of population (3rd largest in NGDP).

·          China has "FOMO MOMO" momentum driven by fear-of-missing-out sentiment, real estate bubble, difficult transition from I to C, healthy consumer, "middle income trap", costlier labor. On other hand, capital stock per capita is low.

·          Asset prices and specifically, stocks, have implicit support from PBoC. Governor Zhou Xiaochuan said: "most enterprises raising capital through the stock market are real-economy enterprises, and this helps the real economy to develop".

·          China has the 2nd largest stock market cap in the world and half of the 10 biggest companies in the world are now Chinese. This isn't reflected in major indices & benchmarks, so funds are underallocated.

·          Lots of tools: RRR and lending rates are still quite high and have room to fall, inflation is 2 p.p. below target, which gives PBoC further room to ease. $1 trillion (which is 10% of GDP) in fiscal infrastructure spending was accelerated in a fast-track approval process in January.

·          On the other hand, real indicators have been all declining, reflecting an slowdown in GDP growth. This is natural and inevitable. The question is if and how the administration will manage it. Furthermore, the stock market has little correlation with economic growth.

 

Long India EPI

·          Reformist-minded PM, who made a success story of his region when he was governor, is elected in an inefficient bureacratic developing economy with a huge labor force.

·          Highest growth prospects in the EM world, although GDP numbers are a bit strange.

·          Hawkish UChicago CB head who gives mkts relative confidence (for an EM CB head) about FX, esp since inflation is low.

·          There is lots of low hanging fruit such as land sale reform, GST (general sales tax). States are getting more power to run their own fiscal policies.

·          However, GDP numbers are not credible. Nobody knows how they get them. High 7-8% growth, up from 5% in the old methodology.

 

Long Eurozone equities (HEDJ)

Short EUR (EUO)

·          Don't fight the Fed -> Don't fight the ECB.

·          ECB QE - low agg new net supply due to low fiscal deficits, low liquidity, low public capital mkts participation (only 35-40% of core EZ debt is held by active managers) are actually a plus, this means that portfolio rebalancing effect will be huge and will force banks to sell bonds and lend to corps and households

·          However, low fiscal debt, deficits and structural reform, monetary union without fiscal union, Juncker Plan, which is the EFSI European Fund for Strategic Investments, has been identified as the ONLY initiative in the EZ where aggregate fiscal stance is concerned. It has largely failed due to national self-interest

·          It's all about the banks. They have stopped deleveraging, but they need to lend to the real private economy: i.e. households and corps. Households are borrowing, corps still are not.

·          Euro project means core gets a weaker currency, peripherals get a lower interest rate. Outcome? Core surplus and peripheral deficits without a regional rebalancing mechanism. This means deflation in periphery to improve competitiveness.

·          Core-peripheral divergence - as long as Germany refuses to run a current account deficit, the rebalancing mechanism will be extremely painful for peripherals. Germany already at potential, UE rate very low

·          Chances of a more open-ended QE is likely: in the last meeting, the bond purchase issuance limit was raised from 25 to 33%, and new language was introduced which says to conduct QE to Sept 2016 "or beyond if necessary". On the other hand, core CPI is solid near 1% and they seem happy with this.

 

Long Japan (DXJ)
Short JPY (YCS)

·          Three arrows is really just 1 arrow: monetary

·          Chances of further QE has increased - unlikely to hit inflation target, weak wage growth, Tankan inflation expectations declined

·          On the other hand, there's been strong household spending and "core core"(ex-food and ex-energy) inflation

·          BoJ has signaled that they may have to get more "creative" in achieving its inflation target. Interpreted this as more ETF and J-REIT purchases. Kuroda has stated that the scale of their ETF/J-REIT purchases is "extremely small". Since economic growth or inflation has not picked up significantly, the likelihood of this has increased.

·          Don't bet on significant fiscal or structural measures

Michael Pettis notes

I heard Michael Pettis speak last week. Here are my notes:

Key conclusions

·         China - we should applaud a sharper growth slowdown, as this would make non-destructive adjustment more likely

o   Low capital stock/capita relative to DM is not a good argument to justify high investment/GDP

o   Watch for SOE privatization, transfers of wealth to households and centralization of power under President Xi Jinping

o   Low chance of further CNY devaluation

Notes:

1.       EM countries have had two unique problems

a.       Very low savings rate

b.      Private sector does a very poor job of identifying productive investments

2.       Old solution was to push up savings, keep savings in the banking system, and have gov't direct investments

a.       How do you force up the savings rate?

                                                               i.      S=GDP-C

                                                             ii.      Reduce consumption (C) by reducing household income share of GDP

                                                            iii.      Side note: need to distinguish hhld savings from total savings

                                                           iv.      Hhlds in China spend as much as other countries - Chinese hhld savings aren't abnormally high

                                                             v.      Total savings are high because hhld income share of GDP is low

3.       Brazil's model - raises taxes, use domestic savings to fund investment

4.       East Asia / Japan model - raises implicit not explicit taxes

a.       1st tax - undervalued FX

                                                               i.      Similar to a consumption tax on imports

                                                             ii.      Subsidizes tradable goods sector

                                                            iii.      Reduces growth of hhld income

b.      2nd tax - have wage growth lower than productivity growth

                                                               i.      Lowers ULC

c.       3rd tax - financial repression

                                                               i.      Set bank deposit rates extraordinarily low

                                                             ii.      Huge transfer from net savers to net borrowers (SOEs, local govts, producers of GDP)

5.       Old argument in favor of high investment/GDP: China has very low capital stock per capita and this needs to converge with DM

a.       This is nonsense - the causation is backwards

b.      Countries aren't rich bc of high investment

c.       Countries have high investment bc they're rich

6.       China started misallocating investment in late 1990s

a.       NPV was less than cost of investment

b.      This leads to debt levels rising faster than debt servicing capacity

7.       Now China is trying to increase hhld wealth at expense of gov't

a.       Two ways to do it

                                                               i.      Japanese way: transfer debt from private sector to gov't

                                                             ii.      Hopefully, China transfers assets & wealth from gov't to private sector

b.      Turning point was (ex-)Premier Wen Jiabao's 2007 four "un"s speech: China is unstable, unbalanced, uncoordinated, unsustainable

c.       Rebalancing are rarely successful

                                                               i.      Historically, only successful under democracies (US in 1930s) or highly centralized autocracies (Deng Xiaoping), but countries in the middle of the political spectrum have a lot of trouble

                                                             ii.      Xi Jinping needs to become Deng Xiaoping and centralize power in order to pass reforms

8.       Ideal slowdown would be for growth to decrease by 100-150bps a year until end of decade

a.       Try to control credit growth -> Inv falls, C is maintained -> GDP falls

b.      Japan in 1990-2010: while GDP grew slowly, consumption growth was steady

c.       Problem is that this comes at the cost of vested interests

                                                               i.      Anti-corruption is about destroying vested interests which benefit under current policies

d.      1st group of reforms is to reduce implicit taxes - this has more or less happened

                                                               i.      Wages are growing as quickly as productivity

                                                             ii.      FX is not undervalued as much as before, look at trade weighted CNY not just USDCNY

                                                            iii.      Standard trade theory says deleveraging low growth DM should have surpluses against high growth China

                                                           iv.      Imbalances have peaked and there have been small improvements - consumption share of GDP has risen 2-3% since bottoming in 2011

                                                             v.      Financial repression has been resolved

e.      2nd group of reforms is actual wealth transfer - hasn't happened yet

                                                               i.      Hopefully starts end-2015 or 2016

                                                             ii.      Third plenum reforms are all about transfer wealth to hhld

1.       Hukou residency reforms - this will allow migrants to have educational/social services/welfare, which will make them richer

                                                            iii.      March 2015, Shandong province announced a transfer of SOE shares into their pension fund

1.       Unfortunately, not a very efficient transfer

2.       Depends on credibility of the pension fund, which is low

3.       Downside is that Shandong inhabitants prob don't feel richer and thus spend more

4.       One virtue is that because the gov't controls the pension fund, it doesn't lose control of the SOE

5.       SOE profitability goes to hhld, but not control

9.       China needs to give up on the 7% growth target

a.       Best-case scenario: 2013-2023 avg growth is 3-4%

                                                               i.      The faster they slow, the less likely the chance of a destructive adjustment

                                                             ii.      West needs to stop applauding high growth numbers from China - we should applaud a sharper slowdown

                                                            iii.      You can have any growth you want - e.g. US could easily have 10% growth today through a credit boom but would  lead to very painful adj later

b.      GDP target is for domestic political purposes

                                                               i.      If they relax this, XJP can be confident about reform

                                                             ii.      If privatization speeds up, this is good - watch for developments here

                                                            iii.      Only just started the adj process, iron prices could fall further

                                                           iv.      Need to recognize losses so that they can allocate capital efficiently

c.       Bad case scenario: 7% for 2-3y then debt capacity limits are hit and system collapses

                                                               i.      If gov't backs all debt, then debt won't stop growing

                                                             ii.      Banking crises usually allocate losses to hhld

                                                            iii.      In China, C needs to replace Inv, so hhld can't take losses

d.      More than 50% chance of best-case scenario (non-destructive adj)

10.   Composition of state reserves is secret, may have illiquid assets

a.       However don't worry, China can take many measures

                                                               i.      E.g. stop outflows with capital controls or devalue FX

b.      Gov't monetizes inflows, prints and buys dollars

c.       Now capital acct outflows are larger than current acct inflows

11.   Low chance of further FX devaluation

a.       PBoC is opposed to further FX deval - PBoC not going to quickly liberalize/internationalize the FX

b.      FX deval transfers wealth from hhlds to tradable goods sector - opposite direction of the correct rebalancing

c.       FX deval might increase outflows

d.      FX overshooting occurs when there's lots of external debt - China doesn't have much

e.      China is pouring reserves to prop FX

f.        If outflows continue at high levels, then they need another solution

                                                               i.      Re-peg? Low chance, this would be a huge loss of face

12.   The idea that the offshore CNY rate (CNH) is a pure mkt expectation of where CNY will go is WRONG

a.       SOEs have ways to arb CNH and CNY - the frictional cost is <2%

b.      SOE will no longer misallocate bc IR are high

morning market color

Greece - Syriza won 145/300 seats, more than expected

o   will need to form a coalition, likely with previous partners Independent Greeks (10 seats)

o   Syriza is bound to austerity program and committed to implementation - this outcome removes ST risks

o   in the prev election, bonds sold off on a Syriza win; on the other hand, now it's a relief to get Syriza elected

·         Fed - mkt can deal with good news or bad news, but it hates uncertainty

o   Sept 17 meeting gave less clarity than mkts would like

o   futures pricing in 51% chance of no hike this year

o   13 "dots" looking for hike this year

o   US tsy 2y yield peaked at 80bps, fell to 66-68bps after the Thurs meeting, now back up to 70bps

o   Yellen speaking on Thurs - hopefully schedules a press conference for the October mtg, but unlikely

·         HY correlates better with eqy mkts than EM mkts

·         Credit spreads widening out while eqy mkts are stabilizing/up - are fixed income investors seeing sthg that eqy guys aren't?

·         Q3 earning season starts in the next couple of weeks

o   historical trend has been for expectations decline to during the course of the previous quarter, earnings beats this declined exp

o   ^ this hasn't happened this quarter

·         Volkswagen (VLKAY) - admitted that their cars met emissions standards only during tests and not on the road

o   diesel sales are halted - this is ~one-quarter of US sales

o   potential penalties/fines of billions of dollars

o   shares down 20% overnight

·         DAX is still up +11bps despite VW

·         Alibaba (BABA) - share lockup period on 63% of shares is ending, may lead to ST weakness

·         Data flow is focused on the US this week

o   M: US existing home sales at 10am

o   T: US FHFA house prices

o   W: PMI day (China, EZ, US, Japan)

o   Th: US durable goods, new home sales

o   F: US Q2 GDP 3rd revision, UMich consumer survey

notes from Ben Bernanke

I had the opportunity to hear from (and even ask some questions to) Ben Bernanke last week at a conference. Here are my notes. My impression is that he would NOT hike right now, but you can decide for yourself:

1.       US is doing pretty well

a.       Heart of the recovery will be will be housing sector - housing recovery is only mid-cycle, will continue to provide gains

b.      US is in a virtuous cycle - increased job creation, higher incomes, low energy prices, better balance sheets due to deleveraging, and more wealth

c.       Hhlds feeling good, decent consumer spending

d.      Domestic economy is firing its cylinders

2.       Biggest puzzle is low inflation and wage growth

3.       Potential growth trend can be decomposed into labor force growth and productivity

a.       On productivity growth, I'm a modest optimist

b.      I would expect this to snap back - things that go down will go up

c.       R&D spend is coming back

d.      Mkts are open, lots of credit availability

e.      Low productivity growth means high job creation and low GDP growth

4.       Fed pays more attention to labor force slack than GDP slack

a.       That's why the Fed is considering hiking despite the output gap

5.       Main risks to US recovery are from abroad

a.       Strong dollar

b.      Weakness in trading partners

c.       I was surprised by the recent mkt reaction to China

                                                               i.      Influence of China on US is indirect and small

                                                             ii.      They're entering the classic middle income trap

                                                            iii.      Hitting the limits of its growth model

d.      China is making gradual, deliberate and careful movement towards mkt and reforms

                                                               i.      Avoid rapid capital flows which are hard to control

                                                             ii.      PBoC is not independent, the admin (XJP & LKQ) will always wins against the PBoC

1.       Gov Zhou is very capable and reform-oriented, but nearing retirement age

                                                            iii.      There's different stories internally about why you want to move to a flexible FX rate

1.       Admin wants to ease monetary policy and to strengthen domestic economy

2.       PBoC, on the other hand, emphasizes reform

e.      China influences the Fed significantly

6.       Financial conditions are now tighter than before; lower eqy prices and higher spreads

a.       This weakens the economic outlook in the Fed staff models

b.      Volatility makes the Fed more cautious than otherwise

                                                               i.      Is the mkt seeing something that we don't understand?

7.       An analogous period to now would be Sept 2013 (see chart below)

a.       After the taper tantrum of May 2013, mkts were expecting taper but we didn't do it

b.      Financial conditions were tighter, mortgage rates risen quite a bit, we believed these conditions were not consistent with tighter MP

c.       We are seeing the same thing now

d.      August 2013 labor figures got revised up as it often does

e.      Tapering in December was the right decision

8.       Timing of the first hike has a lot of informational content despite the small size of the move itself

9.       One aspect of today is that we're at zero

a.       Cost of overshooting and going too soon is higher than otherwise

b.      We'd need to come back to zero and we don't really have any reliable tools at zero

c.       Fiscal policy is off the table

d.      Nobody has ever gotten off of zero - everyone finds themselves back at zero

e.      Take Sweden in 2010-2011  - they raised rates from 0.25%->2%, now they're back at zero!

10.   Look at Stan Fischer's comments at Jackson hole

a.       Ultimately we believe in the Phillips curve and that inflation will come back

b.      Lags in policy, takes some time for ZIRP to work

11.   One of the considerations for MP is financial stability issues

a.       Don't fully understand the linkages with MP

b.      MP is too blunt of a tool - SF Fed study showed that in order for the Fed to pop the 2000s housing bubble, would have had to raise FFR 800bps

12.   Yield curve is forecasting very low future FFR, lower than Fed's forecasts

a.       Risk premiums on long bonds are very low and maybe even negative

                                                               i.      Permanent reasons: less fears of inflation, safe haven demand, portfolio preferences

                                                             ii.      Temp reasons: inflation beta may change, hedge value goes down, global savings glut diminishing (China selling tsys, Europe becoming less of a net saver)

                                                            iii.      Negative risk premiums occur when dangers of deflation/disinflation are high, high hedge value for bonds

                                                           iv.      Higher risk premiums will help mkt forecast converge with the Fed's

b.      If the YC flattens or reverts, this is bad news, I hope this doesn't happen

 

Mkt action in Sept 2013 (vertical line is the Fed meeting)

 

White is S&P 500

Orange is TLT, the long bond etf

Yellow is UUP, the bullish USD etf

Brazil Trip

Each bullet pt is a day

1. I arrive at Sao Paulo, which is kinda like the NY of Brazil. There were some interesting architecture as well...
2. I had to do some unforeseen work and stayed in the hotel the whole day... I was literally so busy I had to order room service for a burger at 3pm for lunch. It was actually surprisingly good. Then I go eat Churrasco (all-you-can eat Brazilean bbq) for dinner.
3. Everyone arrives, we go shopping in Sao Paulo and Chico and I get Havainas slippers (a famous Brazilean brand of slippers?). The Havainas chafe my toes. I experience buyers regret. We take the overnight bus to Rio.
4. In the morning, Andy almost mistakenly sits on a homeless person sleeping in a tarp while smoking cigars at a beach; then we hike up a 2000m elevation mountain to look at the Jesus statue; at night we learn how to dance samba at a night club
5. We went biking and I had explosive diarrhea- that was an interesting combo, and the first of my epicly bad biking experiences. We then flew to Fortaleza that night
6. We stayed in Cumbuco (a 2000 person beach town close to Fortaleza) and learned kitesurfing for 3 days. It was very nice and peaceful, and we had very great learning conditions. We all got epicly tanned and burnt. In the afternoon, we go on a sand buggy ride, sand butt boarding and highlining and take lots of failed selfies because we lack the technical expertise... I manage to do work after all this...
7. After kite surfing, I stay and eat street food while Andy etc go to explore Fortaleza. I try to get Korean fried chicken and fail. I sleep all day and feel happy.
8. On the last day of kitesurfing, we manage to get up and surf for ~10-20 meters. We go demolish an all crabs meal and then bus to recife
9. Recife is where we learn how to mountain bike... from Andy... on urban streets because it was so bumpy... and Andy only teaches us what to do after we have spent 3 hrs dodging NYC-type traffic, cycling on highways and riding through potholes and going up and down huge pavement ledges. We are talking about a 15cm wide by 10cm deep drainage systems. A moat between the car traffic lanes and every single pedestrian pavement that we need to somehow vault across each time... We have totally worked in our Havainas- perfect fits and no more chafing. Unfortunately Chico's Havainas breaks. We also contribute to a bike imbalance between the islands of Recife. We eat Churrasco to replenish our energy.
10. We go to Porto de Galinhas (a beach 2hr bus ride away) and molest seahorses. I drive a manual sandbuggy. I see somebody wakeboarding with a jetski and I am green with envy.
11. We go to Olinda (lots of baroque/1600s-1800s buildings that then got burnt down by the dutch). We stumble into a school parent teacher open day. I realize that we are going to have to walk up and down steep hills for 3+hrs to look at churches. I become dejected and gloomy. Then I become delirious. We sit down for a beer and then lunch and have good philosophical discussions about goats. I become happy again. Then we fly to Salvador. We bring beer and also try to mix our own Caipirinha's on the flight and learn that domestic flights in Brazil don't serve/allow alcohol. When we get to Salvador, we eat the most epic hotdogs ever (according to Andy).
12. We visit a market place, learn Capoeira (dance fighting), and watch epic dance shows about Brazilian gods. We go eat Moqueca stew.
13. We go to a beach. Tuesday night is the designated party night for our region, so we mix our own Caipirinha's and go watch real life Capoeira and party in the streets. We watch a drum group and join a rave.
14. The rest... is interesting as well. My phone gets stolen. We almost get robbed. I am traumatized. I miss my flight.
    

If you enjoyed reading about my trip and my sense of humour, check out my Tanzania trip here!