Joel Bowman, with a few words from Taipei, Taiwan... It's a rainy ol' night here off the South China coast and your editor is busy putting together a deal for a new Mayer's Special Situations research report we'll be rolling out next week. More on that after the long weekend. In the meantime, we turn you over to the capable stewardship of Mr. Puru Saxena. We visited Puru at his Hong Kong office a short while back. Over lunch we discussed Peak Oil, the battle between developed and emerging markets and, of course, the "suicidal" monetary policy of the world's central banks. Puru touches on all of these important points in today's guest weekend essay. We trust you'll enjoy it... Blowing Bubbles By Puru Saxena Hong Kong, China BIG PICTURE - Let's face it; central banks are blowing another asset bubble. As if two burst bubbles in the prior decade are not enough, the money maestros have decided to fuel another speculative orgy. Let there be no doubt, both the technology and real estate bubbles were spawned by cheap credit and it is now clear that the central banks have learned nothing from those two episodes. Despite the fact that near- zero interest-rates caused the previous mishaps, the central banks are (once again) pursuing a suicidal monetary policy. By keeping interest- rates well below the rate of inflation, the officials are encouraging speculation, thereby sowing the seeds of yet another asset bubble. At present, the yield curve is steep in most nations and the cost of borrowing is low, so is it any surprise that asset markets are rallying? All over the world, asset prices are inflating again and dangerous excesses are around the corner. Only this time around, the public sector in the West is already over-leveraged and when the next asset bubble bursts, governments will not be able to come to the rescue. Today, most of the developed world is drowning in debt and various industrialised nations face severe deficits. Moreover, these over- indebted economies are struggling to grow, therefore it is highly unlikely that their stock markets will provide leadership.
Now, given the fact that the developing world is growing much more rapidly, it is highly probable that the emerging market equities will benefit the most from asset inflation. Apart from sporting superior growth rates, it is worth noting that the developing nations have relatively low debt levels. It is our contention that this combination of strong economic growth and compressed leverage will be sure to catch investors' attention. The next chart highlights the huge discrepancy between the fiscal health of the industrialised and developing nations. As you can see, public debt relative to the economy is already very high and likely to surge in the developed world, whereas this ratio is expected to decline in the developing world. Therefore, over the next decade, we can expect more and more investors to shift their capital from the debt plagued developed nations to the healthy developing economies.
Historically, the developing markets have traded at a valuation discount when compared the developed markets. However, over the coming years, we suspect that the 'risky' developing markets will command a valuation premium relative to the industrialised world. Put simply, when you factor future earnings growth and an expansion in valuations, the developing markets are prime candidates for the next asset bubble. Since the turn of the millennium, we have favoured the developing countries in Asia and we continue to like China, India and Vietnam. In our view, these economies will prosper for different reasons and their stock markets will reward long-term investors. Now, there can be no doubt that both China and Vietnam have been disappointing over the past few months, but we view the ongoing consolidation as a fabulous buying opportunity. In addition to the developing nations in Asia, we believe the energy sector is also a worthy candidate for the next asset bubble. In fact, when the realities of 'Peak Oil' dawn in investors' minds, we could witness an outright mania in conventional and alternative energy stocks. Although we recognise that the developed world faces some serious economic problems, we are positive about asset prices for the next 2-3 years. In our view, monetary policy determines the fate of every asset- class and as long as interest-rates are low, the ongoing bull-market should continue. In fact, history has clearly shown that each bear- market in the past was preceded by a period of significant monetary tightening. In every previous bull-market, rising interest-rates was the straw which broke the camel's back. Finally, the last chart shows the Fed Funds Rate since 1998 and plots the two most recent US recessions (pink shaded areas on the chart). As you can see, prior to the 2001 recession, the Fed Funds Rate peaked in mid-2000 and it is this monetary tightening which caused the NASDAQ- bust and the 2000-2003 bear-market. Furthermore, prior to the most recent recession, the Fed Funds Rate peaked in mid-2007 and this monetary tightening was responsible for the credit-bust and the 2007- 2009 bear-market. At present, the Fed Funds Rate is extremely low and if the economic recovery remains intact, then over the following months, interest-rates will rise. In our opinion, the next bear-market will only occur when the Federal Reserve is done raising its benchmark rate for this cycle. Now, given the precarious state of the US economy, we suspect that the Federal Reserve will increase interest-rates in baby-steps and the next monetary tightening cycle should last for at least 2-3 years. If our guesstimate turns out to be correct, the next significant correction in asset prices will occur around 2012-2013 and until then, we intend to enjoy the benefits of cheap money.
Now, before you get excited, we want to caution you that the next bear- market has the potential to be as equally traumatising as the previous one. Remember, when the bear returns in 2-3 years time, governments in the West will be unable to provide more 'stimulus'. By then, their balance-sheets will be in a terrible state and during the next bear- market, sovereign default risk will be the Achilles Heel. So, in the next bear-market, instead of financial institutions going bust, entire nations are likely to default. Given the ominous scenario outlined above, we want to re-iterate that we have no intention of suffering during the next bear-market. Accordingly, we will endeavour to re-position our clients' capital towards the end of this bull-market, so that we are able to preserve our gains over the full business cycle. If our assessment is correct, towards the end of this bull-market, we are likely to see the following red flags:
Puru Saxena for The Daily Reckoning Joel's Note: Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription here. Puru is also the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs. | ||||
| ALSO THIS WEEK in The Daily Reckoning... Beauty is Truth, Part II By Eric Fry Laguna Beach, California Simplicity and honesty are essential investment attributes. Complexity and deception are fatal. Most publicly traded financial firms, for example, reside at the complex and deceptive end of the investment spectrum. They are complicated and highly leveraged...which means the chances of a costly deception (whether intentional or accidental) are very high. The corporate histories of Countrywide Financial, Washington Mutual, Lehman Bros. and Bear Stearns illustrate the point. The Chinese Gold Rush By Chris Mayer Gaithersburg, Maryland While in Beijing last week, I visited the Cai Bai gold market. China is the largest buyer of gold in the world...and becoming larger by the day. Anecdotally, I can tell you the Cai Bai gold market was bustling with people. (I wish I could show you, but a guard promptly stopped me when I pulled out my video camera.) I was there in the middle of the day, and there was a good crowd of people buying gold in all its forms - from jewelry to bars. The "China Story" is Not Dead Yet By Chris Mayer Gaithersburg, Maryland The city of Harbin lies on the banks of the Songhua River in the northeast of China, in what was Manchuria. This 10th largest city in China is a good place to see how some of the best opportunities in the next phase of China's expansion come together. In particular, there are huge profits sitting out there in the expansion of China's rail and subway systems. But first, a little context... As the World Turns: A Few Notes on Emerging Market Investing By Chris Mayer Gaithersburg, Maryland In a recent edition of The Daily Reckoning, Bill Bonner observed, "The world turned against them at the beginning of the Industrial Revolution. But if the world turns long enough, it comes back to where it began." He was writing about India. But he could have been writing about China...or Nicaragua...or any one of a number of emerging markets. To Get Rich is Glorious By Bill Bonner Paris, France Imagine the looks on their faces, when Deng Xiaoping sold them out. The old commies in China had tried to make steel in backyard barbecues. They'd carried the fat Mao on a litter, on a long march to nowhere. They'd pretended his Little Red Book was more than drivel. They'd endured one absurdity after another...purges, starvation, and misery...all for the cause. ------------------------------------------------------- New Report: The key to fast gains in any market... How Penny Stocks Build Overnight Millionaires
------------------------------------------------------- The Weekly Endnote: A very important reminder to round out this Weekend Edition of The Daily Reckoning: According to an email we received from our conference director, Bruce Robertson, a couple of days ago, we have less than 80 seats remaining for this year's Agora Financial Investment Symposium, to be held in Vancouver between July 20-23. The theme of this year's event is: The Assault on Enterprise: How to Invest In an Era of Rising Taxes, Wall Street Crooks and Gov't Boondoggles. If that doesn't get your blood pumping...well...maybe the event isn't for you. Given the smashing list of presenters (full list here), it's not surprising this year's event is on track to be our fastest sell-out on record. If you haven't already done so, make sure to grab yourself a ticket, here. Time's a runnin' out! Enjoy your long weekend... Cheers, Joel Bowman Managing Editor, The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com | ||||
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