The Burning Questions For 2015

Louis Gave is one of my favorite investment and economic thinkers, besides being a good friend and an all-around fun guy. When he and his father Charles and the well-known European journalist Anatole Kaletsky decided to form Gavekal some 15 years ago, Louis moved to Hong Kong, as they felt that Asia and especially China would be a part of the world they would have to understand. Since then Gavekal has expanded its research offices all over the world. The Gavekal team’s various research arms produce an astounding amount of work on an incredibly wide range of topics, but somehow Louis always seems to be on top of all of it.

Longtime readers know that I often republish a piece by someone in their firm (typically Charles or Louis). I have to be somewhat judicious, as their research is actually quite expensive, but they kindly give me permission to share it from time to time.

This week, for your Outside the Box reading, I bring you one of the more thought-provoking pieces I’ve read from Louis in some time. In Thoughts from the Frontline I have been looking at world problems we need to focus on as we enter 2015. Today, Louis also gives us a piece along these lines, called “The Burning Questions for 2015,” in which he thinks about a “Chinese Marshall Plan” (and what a stronger US dollar might do to China), Abenomics as a “sideshow,” US capital misallocation, and whether or not we should even care about Europe. I think you will find the piece well worth your time.

Think about this part of his conclusion as you read:

Most investors go about their job trying to identify ‘winners’. But more often than not, investing is about avoiding losers. Like successful gamblers at the racing track, an investor’s starting point should be to eliminate the assets that do not stand a chance, and then spread the rest of one’s capital amongst the remainder.

Wise words indeed.

A Yellow Card from Barry

What you don’t often get to see is the lively debate that happens among my friends about my writing, even as I comment on theirs. Barry Ritholtz of The Big Picture pulled a yellow card on me over a piece of data he contended I had cherry-picked from Zero Hedge. He has a point. I should have either not copied that sentence (the rest of the quote was OK) or noted the issue date. Quoting Barry:

Did you cherry pick this a little much? 

“… because since December 2007, or roughly the start of the global depression, shale oil states have added 1.36 million jobs while non-shale states have lost 424,000 jobs.”

I must point out how intellectually disingenuous this start date is, heading right into the crisis – why not use December 2010? Or 5 or 10 years? This is misleading in other ways:

It is geared to start before the crisis & recovery, so that it forces the 10 million jobs lost in the crisis to be offset by the 10 million new jobs added since the recovery began. That creates a very misleading picture of where growth comes from.

We have created 10 million new jobs since June 2009. Has Texas really created 4 million new jobs? The answer is no.

According to [the St. Louis Fed] FRED [database]:

PAYEMS – or NFP – has gone from 130,944 to 140,045, a gain of 9,101 over that period.
TXNA – Total Nonfarm in Texas – has gone from 10,284 to 11,708, for a gain of 1,424.

That gain represents 15.6% of the 9.1MM total.

Well yes, Barry, but because of oil and other things (like a business-friendly climate), Texas did not lose as many jobs in the recession as the rest of the nation did, which is where you can get skewed data, depending on when you start the count and what you are trying to illustrate.

My main point is that energy production has been a huge upside producer of jobs, and that source of new jobs is going away. And yes, Josh, the net benefit for at least the first six months until the job non-production shows up (if it does) is a positive for the economy and the consumer. But I was trying to highlight a potential problem that could hurt US growth. Oil is likely to go to $40 before settling in the $50 range for a while. Will it eventually go back up? Yes. But it’s anybody’s guess as to when.

By the way, a former major hedge fund manager who closed his fund a number of years ago casually mentioned at a party the other night that he hopes oil goes to $35 and that we see a true shakeout in the oil patch. He grew up in a West Texas oil family and truly understands the cycles in the industry, especially for the smaller producers. From his point of view, a substantial shakeout creates massive upside opportunities in lots of places. “Almost enough,” he said, “to tempt me to open a new fund.”

It is time to hit the send button. I trust you are having a good week. Now settle in and grab a cup of coffee or some wine (depending on the time of day and your mood), and let’s see what Louis has to say.

Your trying to catch up analyst,

John Mauldin, Editor
Outside the Box 

The Burning Questions For 2015

By Louis-Vincent Gave, Gavekal Dragonomics

With two reports a day, and often more, readers sometimes complain that keeping tabs on the thoughts of the various Gavekal analysts can be a challenge. So as the year draws to a close, it may be helpful if we recap the main questions confronting investors and the themes we strongly believe in, region by region.

1. A Chinese Marshall Plan?

When we have conversations with clients about China – which typically we do between two and four times a day – the talk invariably revolves around how much Chinese growth is slowing (a good bit, and quite quickly); how undercapitalized Chinese banks are (a good bit, but fat net interest margins and preferred share issues are solving the problem over time); how much overcapacity there is in real estate (a good bit, but – like youth – this is a problem that time will fix); how much overcapacity there is in steel, shipping, university graduates and corrupt officials; how disruptive China’s adoption of assembly line robots will be etc.

All of these questions are urgent, and the problems that prompted them undeniably real, which means that China’s policymakers certainly have their plates full. But this is where things get interesting: in all our conversations with Western investors, their conclusion seems to be that Beijing will have little choice but to print money aggressively, devalue the renminbi, fiscally stimulate the economy, and basically follow the path trail-blazed (with such success?) by Western policymakers since 2008. However, we would argue that this conclusion represents a failure both to think outside the Western box and to read Beijing’s signal flags.

In numerous reports (and in Chapters 11 to 14 of Too Different For Comfort) we have argued that the internationalization of the renminbi has been one of the most significant macro events of recent years. This internationalization is continuing apace: from next to nothing in 2008, almost a quarter of Chinese trade will settle in renminbi in 2014:

This is an important development which could have a very positive impact on a number of emerging markets. Indeed, a typical, non-oil exporting emerging market policymaker (whether in Turkey, the Philippines, Vietnam, South Korea, Argentina or India) usually has to worry about two things that are completely out of his control:

1)   A spike in the US dollar. Whenever the US currency shoots up, it presents a hurdle for growth in most emerging markets. The first reason is that most trade takes place in US dollars, so a stronger US dollar means companies having to set aside more money for working capital needs. The second is that most emerging market investors tend to think in two currencies: their own and the US dollar. Catch a cab in Bangkok, Cairo, Cape Town or Jakarta and ask for that day’s US dollar exchange rate and chances are that the driver will know it to within a decimal point. This sensitivity to exchange rates is important because it means that when the US dollar rises, local wealth tends to flow out of local currencies as investors sell domestic assets and into US dollar assets, typically treasuries (when the US dollar falls, the reverse is true).

2)   A rapid rise in oil or food prices. Violent spikes in oil and food prices can be highly destabilizing for developing countries, where the median family spends so much more of their income on basic necessities than the typical Western family. Sudden spikes in the price of food or energy can quickly create social and political tensions. And that’s not all; for oil-importing countries, a spike in oil prices can lead to a rapid deterioration in trade balances. These tend to scare foreign investors away, so pushing the local currency lower and domestic interest rates higher, which in turn leads to weaker growth etc…

Looking at these two concerns, it is hard to escape the conclusion that, as things stand, China is helping to mitigate both:

• China’s policy of renminbi internationalization means that emerging markets are able gradually to reduce their dependence on the US dollar. As they do, spikes in the value of the US currency (such as we have seen in 2014) are becoming less painful.
   
• The slowdown in Chinese oil demand, as well as China’s ability to capitalize on Putin’s difficulties to transform itself from a price-taker to a price-setter, means that the impact of oil and commodities on trade balances is much more contained.