Posts Tagged ‘japan’

In recent weeks, the US Federal Reserve has dropped hints about the imminent end of its quantitative easing programme. At the same time, the Bank of Japan has announced a new, highly expansionary monetary policy, and even at the Bank of England many members, including its Governor Mervyn King, have voted for additional QE for much of this year.

This has created contradictory forces: speculation about the end of QE from the US, but expectations of more in the UK and Japan.

The US economy, however, is more important to the global economy than that of the UK and Japan combined, and in recent weeks markets have allowed their fears about the possible end of QE in the US to outweigh their hopes for more QE from other parts of the world.

In theory QE has the effect of pushing up the price of certain bonds, which in turn makes other assets look relatively cheap. Many argue that QE is the main reason for recent rises in share prices, and that it is therefore creating a bubble which will eventually burst.

On the other hand if the markets reason that QE will lead to inflation, they are likely to demand higher yields on bonds which will force their price downwards, so it is not clear that QE will always lead to higher bond prices. As for equities, it is worth noting that while valuations in equities to earnings may be marginally higher than long term averages, the ratio is not at levels that would normally be considered characteristic of a bubble.

So the jury is out on the overall effect of QE on bond prices and, more specifically, on equities.

However in recent weeks, the price on UK ten year government bonds has risen above the price of the US equivalent, suggesting that markets are selling US bonds in anticipation of the end of QE. They are not selling UK bonds in such large quantities because of hopes that the Bank of England may yet announce more QE. This may lend evidence to the idea that QE does indeed boost bond prices.

But the question remains: what will happen when QE finally comes to an end, whether this is in 2013, 2014, 2015, or at a later date?

When the US Federal Reserve increased interest rates in 1994, the eventual result was the Asian crisis of 1997, the Russian crisis of 1998 and the collapse of LTCM. The US, on the other hand, was largely unscathed.

If QE in the US is coming to an end, what does that mean for the rest of the world? Read the rest of today’s articles for an answer.

The end of QE: Canada and Australia 

The end of QE and the BRICs 

Beyond the BRICs: which emerging markets are vulnerable to the end of QE? 

© Investment & Business News 2013


Good news, it appears, comes in threes. For Spain, it most certainly has been a hat-trick, and we are talking football. If you like your forecast to be made via the prism of half-full crystal balls, then this may be reason to celebrate. Cynics may think differently, however.

Firstly, an index out earlier tracking Spanish manufacturing hit a 24-month high. The latest Purchasing Managers’ Index (PMI) for Spanish manufacturing and compiled by Markit hit 48.1 in May. Now that is news to please both pessimists and optimists. The optimists are celebrating because that was the highest reading since May 2011, and before Spain was in recession. The pessimists remain glum, however, because any reading under 50 is meant to correspond with contraction.

In other words, Spanish manufacturing is still shrinking, it is merely doing so at a slower rate. But then things don’t turn around overnight. The trend has been clear for some: the Spanish manufacturing PMI has been steadily improving. If the upward trajectory continues, then that will be bona fide good news.

Secondly, Spain posted its first trade surplus ever in March. Or at least it was the first surplus for as far back as the records go. Exports jumped 2.7 per cent, perhaps supporting the findings of the PMI. On the other hand, imports fell 13 per cent, that was the main factor behind the trade surplus, and is it really a good idea to celebrate the fact that Spanish households are so under the cosh that they can’t afford to buy foreign goods?

Thirdly, Spanish unemployment fell in May, with 98,286 joining the Spanish work-force. That is good news, of course it is, but not wishing to rain on Spain’s parade, it should be pointed out that Spanish unemployment is currently 26.8 per cent. So Spain needs to see several million more jobs created before it can celebrate. In any case, the main factor behind May data was the tourism trade, and that is seasonal, meaning May’s boost may prove to be a one-off.

Looking at the bigger picture, it does rather look as though Germany is now exporting its economic model to Spain, and there are some parallels between Spain today and Germany during the early stages of the Schroder reforms.

You may recall in the late 1990s and early noughties the German economy looked a lot like Japan, a once seemingly unbeatable economic machine appearing all beaten. But Gerhard Schroder, then Angela Merkel made tough reforms. They hurt. German wages fell;corporate profits in Germany rose. Right now, many Germans are unhappy about bailing out the rest of Europe because they see no sign that indebted Europe is willing to make the kind of sacrifices they themselves made ten years or so ago.

But is the so-called Germanification of Europe such a good idea? The result of rising German company profits was, in fact, a substantial rise in Germany’s savings, and as investment did not rise in tandem with savings, the result was German money flooded abroad, boosting asset prices in, among other countries, Spain.

The global economy, perhaps even Europe, cannot afford to see a rise in planned savings without a corresponding rise in investment. For the global economy, savings must equal investment. This is an economic truism. If savings rise, but investment does not, there must be an immediate offset. Either some sectors of the economy must run up debts equalling the short fall between savings and investment, or the economy must contract.

Either way, aggregate savings must equal aggregate investment. Germanic economics, when applied globally, may lead to global recession, even depression.

© Investment & Business News 2013

QE is drawing to a close; that is reason to panic. QE is set to be ramped up; that is reason to panic. That is what some say who see any news as bad news, including news that is totally contradictory.

The US is back, and the economic crisis is drawing to a close. ‘Celebrate,’ say the optimists. QE is coming to an end, ‘Celebrate,’ they say. ‘QE is set to accelerate, ‘Celebrate,’ they say. The pessimists pretty much say the opposite.

That is the nature of the markets. The news contradicts itself, the markets fall into their two camps whatever it says. They interpret everything as conforming to their pre-existing views.

Just to remind you, in the US, the Fed is dropping hints that its QE programme is drawing to a close.

In Japan, QE has been reignited, but this time in really big fashion. In the euro area, interest rates have been cut to half a per cent. In the UK, there is a feeling that once Mark Carney steps into Mervyn King’s shoes at the Bank of England, we will see a lot more QE.

So that is both more and less QE.

Bond prices have fallen. In the US the yield on US government ten year bonds has risen from 1.6 per cent at the beginning of May to 2.13 per cent by the last day of the month – that was a 14 month high, by the way.

The BIS, which is a lot like the world’s central bank, says this is a taste of things to come. In itslatest quarterly review it talked about the markets living under the spell of QE.

It says that the road will be bumpy as conditions return to normal.

But is that really a reason to fret? Over the last few years the economy has been in crisis mode and low bond yields have been a symptom of that. As we return to normal, surely bond yields will rise, and that is good.

Except, of course, who knows whether we are returning to normal, and indeed markets panic, even when times are good.

If the good times return, markets may well panic over bonds and we may yet see a crash. There is more reason to worry over emerging market bonds. So that’s ironic, impriving economy may be a reason for market turmoil.

But perhaps the fear is that bonds yields rise, even if conditions have not returned to normal. See:The Great Reset

© Investment & Business News 2013

Time was when people thought a bubble was something kids blew, and you put into a bath.

Time was when the South Sea Bubble and Tulip Bubble were things that only historians seemed to know about. “This time,” to coin a phrase, “it is different.” Bubbles are now things that not only all investors know about, but non-investors do too.

Joseph Kennedy sold his stock after a shoe shine boy asked his advice on what stocks to buy. “I smell bubble,” thought Joe, or words to that effect, and the Kennedy family fortune was made. But what happens when a shoe shine boy asks you if there is a bubble in the making? It feels a little like that now. Whenever anything rises, the popular press cries bubble, unless it is UK house prices of course, because the lesson of bubbles doesn’t seem to have infiltrated the psychology of baby boomers as far as UK house prices are concerned.

It is, of course, tempting to say that equity prices are so high because of QE: that once it is reversed equities will crash like a child’s bubble wand thrown to the ground in a fit of temper. Yesterday, 23 May, equities saw sharp falls after minutes from the Fed hinted that QE may be coming to an end.  See Fed at sixes and sevens.

Then again, look at valuations, and things don’t look too serious. See: Are the stock markets set to crash? 

The fear however – and this is where bubble comes in – is that corporate earnings themselves are not sustainable. It is a puzzle how company profits and the economy have been moving out of alignment. In the long run either the economy will adjust upwards to reflect corporate strength, or profits will fall to reflect economic weakness.

If we see the latter of these scenarios then equities probably will crash, and we will be able to look back on the last year or so and say that the period saw the formation of a bubble. And we might add that it was so obvious that it’s a puzzle why people couldn’t see it at the time.

The next possible bubble relates to bonds. QE has pushed up the price of bonds with interest rates being so low that they are even negative in Germany for some government bonds. It seems inevitable they will fall in price, and fall sharply too. Indeed in Japan, government bonds have been falling in price of late, despite QE. That really is a source of concern.

A few days ago it was told here how the ITEM Club reckons inflation may rise in the West as Chinese wages increase. This may be just the catalyst to lead to bond prices crashing. See: Will rising inflation spoil the market’s party?

Another danger area relates to emerging market debt. This is a big topic and will be discussed in more depth at a later date. Here are some headlines for you to consider. Between 2002 and today, outstanding credit in China rose from around 110 per cent of GDP to around 180 per cent. Over the same time frame outstanding debt In Brazil rose from around 30 to roughly 80 per cent of GDP. The average cost to households of servicing their debt to their income is around 22 per cent in Brazil against 10 per cent in the US.

Emerging market debt is a problem. It often works out like that after a period of rapid growth, but bear in mind that in South East Asia, things may be different this time. You may recall that during the 1990s the region boomed, took on too much debt, and crashed in 1997. This time around however, much of the boom has been funded internally for domestic savings. “Local investors hold 88 per cent of domestic government notes in the Philippines, 85 per cent in Thailand and 73 per cent in Malaysia,” stated this article from Bloomberg. See: Record Bond Sales Showing Lessons of 1997 Learned: Asean Credit

A bigger fear relates to demographics. In Europe, both East and West, the US, Japan and indeed China, aging is a problem. For Japan it is hard to see how government debt more than approximately 230 per cent of GDP will be affordable when the working population starts to shrink. But this has already happened. Maybe this is why Japanese government bonds have been falling even as the central bank kicks off more QE. Japanese households are not saving like they used to either; in fact, the Japanese savings ratio is much lower than that of the UK. This may be a symptom of the fact that the Japanese baby boomer generation has already retired, and is drawing down savings to fund day to day living.

In China, the country will shortly pass what’s called the Lewis Turning Point and will run out of workers to migrate from the country to cities. Its policy of one child per family is taking its toll too. But even when the government reverses this policy, getting the birth rate up may prove quite difficult – not least because of the high proportion of younger males to females in the population. By 2030 China is expected to have a shortage of around 140 million workers, according to the IMF.

That leaves one more bubble to warn you of, and this relates to US student loans. See: Student Debt and the Crushing of the American Dream 

© Investment & Business News 2013

In Japan the Nikkei 225 had risen from 8,515 back in October to 15,627 earlier this week. Yesterday the index lost 7.5 per cent, falling back to 14,483.

In the US, the Dow rose from 12,542 last November, to 15,387 earlier this week.

In the UK the FTSE 100 rose from 5,605 last November to 6,840 earlier this week, yesterday it lost 2 per cent.

So this begs the question: why?

News that the Fed may be set to bring its policy of QE to an end later this year did not help, see Fed at sixes and sevens.

News that the latest flash composite PMI measuring Chinese services and manufacturing has fallen below the critical 50 no-change mark for the first time since last October, did not help much either.

See: China stumbles, Eurozone limps

But then again, maybe the real catalyst for yesterday falls is that after a period when shares have risen sharply these things happen. What goes up eventually comes down.

So yes, yesterday the FTSE 100 lost 2 per cent but, no its falls were not even enough to reverse the overall gains seen this week.

Yes the Nikkei 225 lost 7.5 per cent, but its closing price yesterday was still up on its level seen just 10 days ago.

And the Dow did not actually fall that much at all yesterday – down by just 0.08 per cent on Thursday.

Here are a couple of observations and then a warning.

Observation number one: the all-time high of 6930 set for the FTSE 100 in December 1999 remains elusive. Back in 2007, the index went close, moving within 200 points before crashing. This week the index went within 90 points before yesterday’s mini crash. Will the index fail to pass that level yet again in this cycle, before a sense of realism descends on the markets, or was yesterday’s fall just a blip on the steady march to new ground?

Observation number two relates to the news out of Japan, which is less rosy. The markets have gone Shinzo Abe mad. Abeonomics has done for markets what LSD did for hippies during the ‘60s, yet the feeling that the markets have gone too far, are a tad too euphoric, won’t go away.

What they call the cyclically adjusted pe – or the CAPE – which is to say stock market valuations as a proportion of average earnings over the previous ten years, was 28 for the Nikkei 225 before yesterday’s falls. To put that in context, last autumn the CAPE for the Nikkei 225 was just 18. For the US S&P 500, the CAPE is currently around 24. The US average CAPE since 1900 has been 15. The average for the Nikkei 225 since 1985 was 40.

But the US CAPE from 1900 probably understates reality, because earnings growth during the 20th century was rapid. The average CAPE for Japan probably overstates reality, because it was distorted by the exceptional bull run of the 1980s and 1990s.

Earlier this week, Capital Economics forecast that the Nikkei 225 would lose 15 per cent over the remainder of this year. Yesterday it lost half this amount in just one day.

Of more concern is that the yields on Japanese government bonds have been rising of late, and that is despite all the new QE we keep hearing about.

And that brings us to the warning.

There are bubbles in the making: in fact four distinct bubbles come to mind.

 © Investment & Business News 2013

Let’s hope you are sitting down because this may come as a shock. It turns out that a lot of Brits are not saving enough.

According to Prudential: “One in seven (14 per cent) people planning to retire this year will depend on the State Pension as they have no other pension.”

The Prudential analysis also reveals that nearly one in five (18 per cent) of those planning to retire this year will be below the poverty line. The Joseph Rowntree Foundation estimates that to be above the poverty line a single pensioner in the UK needs an income of at least £8,254 a year, yet 18 per cent of those retiring in 2013 expect to retire on less than this.

The findings also highlight a significant gender divide, with 21 per cent of women expected to retire below the poverty line in 2013 compared with 14 per cent of men. In addition, women are nearly three times more likely than men to have no other pension – 23 per cent of women retiring in 2013 will retire without a private pension, compared with just 8 per cent of men.

The truth is that the retirement of the baby boomers, something we are only just beginning to experience, will provide the single biggest challenge to the UK economy over the next few decades. Indeed the US and much of Europe face a similar challenge.

You could say that what is happening in the UK now happened in Japan 20 years ago.

What is the answer?

From a micro point of view it is for us all to save more. But if we all save more, the result may be recession and falling wages, which in turn may make it harder to save.

From a macro point of view we need investment into innovation, infrastructure and just in trying to create a more dynamic and stronger economy. Or we need more immigrants, which is not an idea that is likely to prove very popular.

© Investment & Business News 2013

Last year I did a list of each country’s national debt divided by population to see what the next generation might either pay interest on or pay back.

Examples in $1000 per head:

UK 26.5

Ireland 35

Germany 28

France 31

Spain 17.5

Italy 38

Japan 83

USA 29

Canada 37

Norway 39

Australia 11.5

So what you might say? As a percentage of GDP it’s not so much … well that’s got naff all to do with it too unless there is a current a/c surplus … if you cut someone’s hair it adds to GDP but it hardly pays the £26,500 you owe on top of the £10,000 on your credit card.

Obviously, in the UK, with the old folks about to fund the out of work young folks as well as the civil servants, NHS etc (biggest GDP earners presumably and therefore the biggest ‘so what’ in this whole sad tale) this black hole is here to stay for a long time.

To get away from the obvious side of the story let’s have a look at the other side of the loans – the £26,500 each and every one of us had borrowed on their behalf… someone is the lender and so they will either ask for it back one day or extend the loan forever and the borrowers (you) will pay the interest. As the banks already went bust then presumably the debt is met by bond issuance from each government … “wow government – must be safe” bonds of course.

So who owns the bonds? i.e who is hoping to get paid back?  As it’s not countries per se nor banks so much, it must be the pension funds and the pension funds have your money in trust for when you retire. So the money they are going to give to you one day is indirectly the money you already owe ? And in order to realise that money, the pension funds have to redeem the bonds so the government has to find the money to give the pension providers to give to you….. enough of that … the real truth is that the government bought votes by indirectly spending your pension fund over the past few decades. The government borrowed from the very people it was robbing at the time. Many pension plans will have to go pear-shaped… whose will be first?  Do you doubt this? In that case just tell me who is going to produce your £26,500?

Any thoughts out there?

Patrick O’Connormist is this week’s guest contributor to The Money Spy blog