Demographics making their way to the main stream

Is it confirmatory bias if I happen to read an article in the popular press that happens to support a point we made here a few days (and months) ago about demographics being a good indicator for long cycles, but bad on timing? Just some sampling from the article:

Simple Demographics Shows Why US Housing Is Screwed, Japan Is Doomed, And Vietnam Is The Place To Be

(This guest post comes courtesy of The Mad Hedge Fund Trader)

Desperate homeowners counting on a “V” shaped recovery in residential real estate prices to bail them out better first take a close look at global demographic data, which tells us there will be no recovery at all. . .

…It turns out that population pyramids are something you can trade, buying the good ones and shorting the bad ones. These graphical tools told me in 1980 that I had to sell any real estate I owned in the US by 2005, or face disaster. No doubt hedge fund master John Paulson was looking at the same data when he took out a massive short in subprime securities, earning himself a handy $4 billion bonus in 2007. To see what I am talking about, look at the population pyramid for Vietnam.

This shows a high birth rate producing ever rising numbers of consumers to buy more products, generating a rising tide of corporate earnings, leading to outsized economic growth without the social service burden of an aged population. This is where you want to own the stocks and currencies.

Now look at the world’s worst population pyramid, that for Japan. These graphs show that a nearly perfect pyramid drove a miracle stock market during the fifties and sixties which I remember well, when Japan had your textbook high growth emerging market economy.

That changed dramatically when the population started to age rapidly during the nineties. The 2007 graph is shouting at you not to go near the Land of the Rising Sun, and the 2050 projection tells you why. By then, a small young population of consumers with a very low birth rate will be supporting the backbreaking burden of a huge population of old age pensioners.

Every two wage earners will be supporting one retiree. Think low GDP growth, huge government borrowing, deflation, and a terrible stock and housing markets. If you are wondering why I am aggressively shorting the yen right now, this is a big reason. Dodge the bullet.

If demographics is destiny, then Americas outlook sucks. Brace yourself. We are turning into Japan. As a silver tsunami of 80 million baby boomers retires, they will be followed by only 65 million from generation “X”. The intractable problems that unhappy Japan is facing will soon arrive at our shores. Boomers, therefore, better not count on the next generation to buy them out of their homes at nice premiums, especially if they are still living in the basement, and not paying any rent.

…Vietnam was one of the top performing stock markets in 2009. It was a real basket case in 2008, when zero growth and a 25% inflation rate took it down 78% from 1,160 to 250. This is definitely your E-ticket ride. Vietnam is a classic emerging market play with a turbocharger. It offers lower labor costs than China, a growing middle class, and has been the target of large scale foreign direct investment. General Electric (GE) recently built a wind turbine factory there. You always want to follow the big, smart money. Its new membership in the World Trade Organization is definitely going to be a help.

Read more: http://www.businessinsider.com/simple-demographics-shows-why-us-housing-is-screwed-japan-is-doomed-and-vietnam-is-the-place-to-be-2010-4#ixzz0kwuvY6H0

This is in no way a recommendation to buy Veitnam or is this a suggestion that this is an indicator that can be used in a timely manner. However, it may make sense to look at the long term demographics for long term investing.

Japan’s big currency bet

I just couldn’t help bringing this up, especially since this morning’s Connect the Dots:

Because foreign currency reserves are viewed as a form of insurance, the risks of excess reserves are often overlooked. Japan holds reserves equal to 20% of GDP, more than it could possibly need for insurance purposes. These holdings make up a foreign asset portfolio that is subject to exchange rate risk. However, this risk is hidden because Japan’s reserves are primarily held in U.S. dollars and their value is reported in U.S. dollars. So as the local and global purchasing power of the dollar falls there is no change in the reported value of the reserves. As shown in the chart, Japan’s reserves increased by over $100 billion since June 2007, but fell by nearly ¥20 trillion when measured in local currency terms – over 4% of GDP. The risk of large losses in national wealth is even greater for China, whose reserves make up 50% of GDP. This risk will become apparent as and when China allows the renminbi to appreciate, in line with market pressures.

Source: http://blogs.cfr.org/geographics/2010/03/24/japan/

The question here is whether you want to invest alongside Japanese and Chinese government traders. I do not.

Was Japan’s QE announcement the top?

Will this week mark the cyclical top of the recent rally? I have been writing that there is a disconnect between the fundamentals of the equity market (unemployment, historically high margins that will compress, high P/E, etc.) and the performance we’re seeing. Meaning that the market was being driven by speculative positions which were probably based on flows, carry trade, global quantitative easing measures, etc. and NOT by an increased world GDP nor productivity gains.

So we’re left asking whether Japan’s signal of increased QE will market the top. I have a feeling it might. Maybe we’ll make another run, but the dislocations will have to come into balance. The interesting market will end up being the Treasury market. With flows coming into the USD, were will they sit if not in Treasuries? Not sure yet, but again, just food for thought as we position into year end and adjust medium term allocation.

Not comfortable going into the weekend

Japan back in deflation mode (http://www.ft.com/cms/s/0/44fea966-d59c-11de-b80f-00144feabdc0.html), USD unstable, weak government officials who will need to make bold statements over the weekend, yields going negative (but everyone saying don’t worry)…this doesn’t smell right. Problem is, if you’re not already positioned, it will be tough to do in the next 12 minutes. But the currency markets are the ones I’ll be watching especially closely this weekend.

China rushes towards a Japan-style bubble

This is a must read for anyone even thinking about investing in China. It’s not that they won’t go up from here, it’s just that what you see isn’t always what you get. In the article Peter Tasker compares China to late-90′s Japan. The essence of his logic is that investors cannot know what the true risks of the Chinese markets are here, and if anything, the actual risks are being underpriced, with future growth and spectacular profits expected and overvalued simultaneously.

http://www.ft.com/cms/s/0/39f61cb6-c818-11de-8ba8-00144feab49a.html?nclick_check=1

Chris Wood from CLSA says Emerging Asia to be prime beneficiary of Fed policy

I had to post this. It is a perfect example of how 2 people can look at exactly the same thing and come out with different conclusions. Chris Wood from CLSA is great and I love his research. He contends that the easy money coming from the US will flow to produce a bubble in Asia. I agree on some level, although I think it also helps prop up the bubble here in the US. What I take issue with is his use of the word “beneficiary”. He implies that Asia will benefit from the US policy, where I see it as incredibly dangerous for Asia. Unlike the US, Asia does not have the institutional depth to deal with the inevitable crash implied by Wood’s bubble. Social unrest will be the most dangerous force at play in Asia if and when the US easy money policy abates. I do not think they are benefiting from the policy; on the contrary, I think they are being put at risk and the money flowing there is ephemeral and fickle. Hong Kong real estate prices, in some places calculated to be $8,000 PER SQUARE FOOT will come down sooner or later. If they just equalize with New York’s $1,000 per square foot, it will represent an 85%+ loss. It will either come from the currency or the property, but it will come. That doesn’t sound like so beneficial to me. Here’s the full article from Wood:

Is the U.S. Economy Turning Japanese?
Easy money from the Fed hasn’t translated into more consumer lending by banks.
By Christopher Wood

Happy days are here again in world stock markets. Yesterday’s profit-taking notwithstanding, the Dow Jones Industrial Average is flirting with 10000 and the S&P 500 is up 60% from its March low. Still, if risk-seeking behavior has returned to financial markets, much of it is funded by borrowing increasingly cheap U.S. dollars. There is also very little evidence, if any, that consumption and employment are really recovering in America.

With the U.S. government stepping in to keep markets from clearing, today’s U.S. economy in many ways resembles the post-bubble Japanese economy of the 1990s. Ultra-loose monetary policy and low demand for credit, combined with high unemployment and consumer deleveraging, could lead to a prolonged slump.

Consumption, which still accounts for 71% of total nominal GDP in America, is still weak, and there remains little reason to expect it to pick up in a healthy fashion. Aside from the well-known and related issues of high household debt and negative equity in houses, the latest U.S. employment data have highlighted the still dismal state of the job market. Average weekly earnings of production workers rose by only 0.7% year on year in September as the average number of weekly hours worked fell to a record low of 33 hours. This marks the lowest annualized weekly earnings growth since the data series began in 1964.

Meanwhile, there’s an unhealthy reliance on government for growth in America’s increasingly command-driven economy. This is clear from the severe slump in car sales post “cash for clunkers.” U.S. auto sales declined by 35% month on month in September to an annualized 9.2 million. It’s also clear from the enormous role now played by government in the residential mortgage market. Government-guaranteed mortgages accounted for 98% of total mortgage-backed security issuance in the third quarter.

The reality of an increasingly command-driven economy in America means that government policy is likely to become the key determinant of where investors should place their money. For example, the near-term prospects for the housing market in the U.S. will be strongly influenced by whether the federal government extends its first-time home-buyer tax credit when it expires in November. Like cash for clunkers with autos, the risk is that such a program is simply buying demand from the future.

The other risk is the same as subprime mortgages—encouraging people to buy houses who may be better off renting. This is suggested from the growing delinquency rates on Federal Housing Administration (FHA) approved loans since the FHA has taken over from Fannie Mae and Freddie Mac as the prime way of increasing U.S. taxpayer exposure to future residential mortgage defaults. The default rate on FHA-insured mortgages was already running at 8.1% in August, up from 5.7% a year ago.

Then there’s the government involvement in the U.S. financial sector. Over the past two years the federal government is estimated to have lent, spent or guaranteed around $11 trillion to the financial sector, broadly defined. This is due to Washington’s slavish adherence to the absurd notion that financial institutions can be “too big to fail,” be they called Fannie Mae, AIG or Citicorp.

All of the above behavior invites legitimate comparisons with post-bubble Japan, where banks took years to be cleaned up as a result of regulatory forbearance. The same kind of forbearance is preventing America’s increasingly distressed commercial real-estate market from clearing. Similarly, as was the case with Japan, monetary-base growth has exploded in the U.S. over the past year courtesy of the Fed, while bank lending is declining. This is why there is every reason to fear that America is already in a Japanese-style liquidity trap.

True, Japan’s bubble economy was much more about corporate-debt excesses, most of it borrowed against land or property collateral, rather than personal debt, as is the case in the U.S. But if the comparisons between the two countries are far from precise, the Japanese example shows how investment behavior changes if a deleveraging deflationary trend becomes entrenched.

This can be seen in the dramatic change in Japanese institutional investor asset allocation between government bonds and equities. Japanese insurance company and pension fund share of assets in domestic stocks peaked at 37.2% in fiscal 1988 (which ended March 1989, near the height of the bubble) and has since collapsed to 6.4% at the end of fiscal 2008, while their share of assets in Japanese government bonds surged to 36% in fiscal 2008 from 3.2% in fiscal 1990.

By contrast, in America institutional investors remain overweight equities and underweight government bonds. This will change radically if the U.S. truly is in a deleveraging cycle. Still, the process will take time. It was not until 1998 that Japanese insurance companies and pension funds had a greater percentage of their assets in government bonds than equities.

This is why Wall Street should make the most of the rally in U.S. stocks while it lasts. The next bubble in asset markets will not be in the West but in emerging Asia, led by China. The irony is that the more anaemic the Western recovery proves to be, the longer it will take for Western interest rates to normalize and the bigger the resulting asset bubble in Asia. Emerging Asia, not the U.S. consumer, will be the prime beneficiary of the Fed’s easy money policy.

Mr. Wood, equity strategist for CLSA Ltd. in Hong Kong, is the author of “The Bubble Economy: Japan’s Extraordinary Speculative Boom of the ’80s and the Dramatic Bust of the ’90s” (Solstice Publishing, 2005).

Hoisington: Yields could reach Japanese levels

I am not a big fan of Treasuries at these levels, but Hoisington makes some incredibly well researched points that are worth noting. If we are, indeed in a Japanese style cycle of increased government debt, crowding out of private investments, and stagnant GDP growth, we could be facing a long term deflationary environment with a decreasing per capita GDP, and falling yields. Worth reading all the way through: http://www.hoisingtonmgt.com/pdf/HIM2009Q2NP.pdf.

Reasons to remain a bear

Reasons to remain a bear

Buffett taught us that Mr Market is so irrational that only a fool would try to predict his short- and mid-term movements. So I stick to his teachings and continue to pick what I believe are undervalued companies and remain almost fully invested, as I do find interesting opportunities these days. However, given the horrible economic data that keeps pouring in – it’s hard for me to hold back my bearish sentiment. It almost hurts to read headlines these days. How can the press unanimously celebrate 2-3% growth in industrial order intake vs last month if year-on-year numbers are still down 10-20% or more (and we are now comparing to weaker, post-boom numbers)?

Anyways, these links provide fodder for the bears:

US: never before in post-Depression era has consumer credit fallen so dramatically (despite all the government stimulus):

To say that these figures are ugly would be an understatement. In fact, there is simply no way you can spin this – while this contraction in credit has to happen it has horrifying implications if our Washington policymakers don’t get on the stick and deal with the underlying issues here and now instead of pretending that everything is ok or worse, try to “borrow our way to prosperity.”

The important point is that we have never been here before in the post-Depression era.  Any and all claims that “The Consumer has reached a bottom”, or “The Recession is over” (based on July data) or any such is pure nonsense. There is not only no sign of a bottom there is no change in the second derivative – that is, the rate of change continues to be essentially straight down!

http://market-ticker.denninger.net/archives/1418-The-Governments-Effort-Has-Failed.html

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Japan’s Debt Mountain

If there is a reason to expect about a prolonged economic winter in Japan, the most likely cause would appear to be an unsustainable level of sovereign debt. Thanks to nearly two decades of “stimulus,” Japan is burdened with debt like few other countries. Debt-to-GDP in Japan is now almost 220%. Netted against the large US dollar cash holdings Japan acquired in efforts to manage the dollar-yen exchange rate in the last decade, Japan’s net debt-to-GDP ratio is “only” 103%. But the ratio will surely grow higher. Japan’s budget deficit which had oscillated between 3% and 7% of GDP over the past five years, is running at nearly 10% in 2009.

It is hardly noteworthy in 2009 that the world’s second largest economy doesn’t meet the criteria to have qualified for European Union membership under the Maastrict treaty. Few of the other major economies do either, these days, least of all the United States. But to the simple-minded such as myself, it does seem odd that a nation with even a couple of credit metrics which rate on par with Weimar Germany and Argentina circa 2001 can hold down a “AA” credit rating. Stranger still are 10 year Japanese Government Bond (JGB) yields of slightly less than 1.3%.

http://www.gurufocus.com/news.php?id=68813

A short trip to the late 1980′s…

The other day, after reading Richard Russell, who I admire, I realized I was confused. In and of itself, that is not a big surprise, but I find myself being confused by the same set of incongruent arguments that I see a lot of strategists making. Russell laid out his thesis that Obama was following in FDR’s footsteps of big government spending and then dollar devaluation. He also laid out his thesis of the Chinese being smart long-term thinkers by buying up hard assets and a slowing world economy. Hmmmm.

I just don’t understand how certain aspects of this type of argument (and I hear it all over the place) can coexist. He believes that deflation will win out and at the same time we should accumulate hard assets (represented by gold). He believes that US government will try but fail to inflate us out of a deep recession (meaning consumer spending will continue to decline, meaning people will buy less stuff) yet he believes that the Chinese accumulation of these assets used to produce said “stuff” is strategically wise. I don’t get it. You can agree that the US will try to inflate us out of the debt obligations. But then we’ll face inflation and the commodities seem appropriate. If you think they won’t be able to inflate, then why commodities?

At it’s heart, is he just saying the commodity “super-bull” is still in tact because of emerging-markets-led growth? Is he saying he’s a believer in decoupling (i.e. US is going down and China going up)? I don’t know, but I don’t buy it. I’m not betting on China being a good allocator. I certainly wouldn’t bet on them being good traders (remember their timely investment in Blackrock?). And given their shaky institutional foundation, I wouldn’t bet on their currency either. It’s not to say that commodities won’t go up or that the dollar won’t go down, I just don’t know if his arguments are sound. Am I missing something? I wouldn’t be surprised.

So before we all go out and invest in China and leave the US for dead, I decided that in honor of 4th of July coming up, I’ll revisit history and try to learn something about how we’ve done in past periods…

Today, we’ll start with a short trip to the late 1980′s. Japan ran a massive current account surplus with the US. The US became a net debtor nation as American’s bought Japanese goods, from stereos to cars. At the same time, Japan was limiting American exports and the political backlash was growing. Chuck Schumer (yes, he was around then) was asking Congress to erect trade barriers in retaliation. In Japan, the mood was exuberant, to say the least. Property prices in the center of Tokyo reached north of $93,000 PER SQUARE FOOT!!!

In that light, let’s see what the New York Times articles looked like. Here’s a random sampling…

“Market Place: Perceptions Differ on US Stocks” (1988)

http://www.nytimes.com/1988/11/21/business/market-place-perceptions-differ-on-us-stocks.html?scp=35&sq=japan%20buying%20america&st=cse

IT is a tale of two countries, and of widely varying sentiments. In Japan, all looks rosy and stock prices are setting record after record. In the United States, fears are rapidly rising that the dollar’s decline will continue, and share prices are falling.

Japanese investors, fearing that the plunge of the dollar will continue, are said to be pulling money out of the United States and sending it home.

“Japanese Buying a Place on Wall Street” (1987)

http://www.nytimes.com/1987/04/12/weekinreview/japanese-buying-a-place-on-wall-street.html?scp=15&sq=japan%20buying%20america&st=cse

Many analysts regard a Japanese challenge to Wall Street as inevitable simply because of the shifting balance of economic forces. The United States, with its enormous trade and budget deficits, is now a debtor nation importing huge amounts of capital. Japan, whose exporting prowess is generating huge trade surpluses, is a creditor providing capital to the world.

”The reality of life is that banking and investment banking always gravitate to where the capital is, and the capital is in Japan,” said Felix Rohatyn, a senior partner at Lazard Freres & Company and the matchmaker in the deal between Sumitomo and Goldman, Sachs. ”What they are gaining with their investments is training and technology and a foothold.”

“Bush Will Let Japanese Buy Hercules Unit” (1990)

http://www.nytimes.com/1990/07/28/business/bush-will-let-japanese-buy-hercules-unit.html?scp=19&sq=japan%20buying%20america&st=cse

The Semi-Gas purchase also has opposition in Congress. Representative Mel Levine, the California Democrat, said after the President’s decision today that the endorsement of Nippon Sanso’s bid was ”an unconscionable abandonment” of the President’s responsibilities on national security.

”Does the President care who controls American’s strategic industries and our economic future?” Mr. Levine asked. ”Mr. Bush has sold off a critical piece of American’s economic pie to the Japanese without blinking an eye.”

“Japan’s Appetite for US Mergers” (1988)

http://www.nytimes.com/1988/07/28/business/japan-s-appetite-for-us-mergers.html?scp=56&sq=japan%20buying%20america&st=cse

The Nomura Securities Company, the world’s largest securities concern, said today that it would pay $100 million for a 20 percent stake in one of Wall Street’s hottest mergers-and-acquisitions firms, a sure sign that a Japanese spree of buying American companies is just beginning.

“Japanese Buy New York Cachet With Deal for Rockefeller Center” (1989)

http://www.nytimes.com/1989/10/31/business/japanese-buy-new-york-cachet-with-deal-for-rockefeller-center.html?scp=53&sq=japan%20buying%20america&st=cse

The deal, which comes almost exactly 50 years after Rockefeller Center opened on Nov. 1, 1939, is only the latest instance of the Japanese buying a vital piece of the American landscape, from Hollywood to Wall Street. In September, the Sony Corporation bought Columbia Pictures for $3.4 billion.

Of course, this last deal was announced October 30, 1989. On December 31, 1989 the Nikkei stock index hit its all-time high when it reached an intra-day high of 38,957.44 before closing at 38,915.87. In October 2008 the Nikkei stock index reached a 26-year low of 6994.90. It’s now hovering under 10,000.

So what can we learn from this? The lessons depend on your lens. For starters, we can learn that politicians and prognosticators are rarely right. That aside, some lessons for our fearless leaders are that trade barriers usually don’t end well, asset prices impact financial markets and in turn the “real economy”, markets can stay down for a long long time, the US financial markets are resilient and flexible, etc. But let’s get into more details.

The US might be in a similar position to Japan in the 1980′s. Cheap credit fueled an asset bubble that in turn fueled a financial bubble that led to a collapse. No amount of easing or government prodding could stop the deleveraging that needed to occur and you can’t force people to spend, even when rates are virtually held at zero. At the time, US economists were quick to point out that Japan’s zombie banks and corporations should be allowed to fail, yet we are not taking our own advice, and are increasingly following in Japan’s misplaced footsteps. Japan faced a deflationary spiral that was led by the collapse of real estate, which we might face as well. The Japanese stock market, 20 years later is still 60-70% BELOW its peak, which we might face as well. Certainly the Nasdaq can.

What else can we learn? People have been calling an end to American ingenuity for years, without much success. America has significant natural, labor, capital and political resources that take time to play out. After the attack on Pearl Harbor, General Yamamoto is quoted as saying, “I fear all we have done is to awaken a sleeping giant and fill him with a terrible resolve.” America, as a sleeping giant, takes a while to wake up, but is difficult to fight once awake. In the course of a year, American’s have increased their savings rate from slightly negative to high single digits and going higher. Despite massive flooding by an anxious political order, the public is cutting its debt and putting their house back in order. It will take time to realign, but it might lead to America self financing. This will occur when deposits in banks aren’t lent out (because no one wants to take the leverage) and need to be invested in US Treasuries, crowding out or relieving, whichever you prefer, foreign purchases.

So, let’s start where we began. I do not see China decoupling from the US. One is integrated with the other. If the US slowdown continues, China will face increasing challenges to its export dependent model. If China does grow, it will also help the US and dampen our recession. The US consumer is doing what needs to be done. It will take time, but it does not mean that the US economy will be down forever. And lastly, I’ve said this before, Japan is looking increasingly attractive after 20+ years of waiting.