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Emerging Market Hedge

This morning I'm reporting on Thai economic growth over at TheStreet.com, and how amazingly, in the global liquidity crunch, it's managed to trend upwards -- and fairly fast, too:

In August, year-over-year exports in Thailand rose 17.9% vs. a rise of 5.9% in July, while the country's trade surplus rose to $770 million from $211 million. And at the end of September, the Ministry of Finance revised economic growth for the year up 50 basis points to 4.5%, and at 31.64 vs. the dollar, the baht is climbing its way back up to its July levels.

The scenario is a far cry from 1997, when the baht dropped 30% overnight vs. the dollar and Thailand was thrown into a cash crisis.

Now, contrast this scenario with the U.S. economic outlook:

As of Friday, Thomson Financial pegged overall third-quarter earnings growth for the S&P 500 at an anemic 1.4% rate. Should that come to pass, it would be the worst performance since the second quarter of 2002, when earnings rose by the same amount.

Analysts note that a weaker U.S. dollar, which continually set record lows against the euro during the third quarter, undoubtedly aided some export-heavy sectors. Unfortunately, the belief is that housing woes and a slowdown to the U.S. economy will sabotage profit growth for many.

"Downward estimate revisions have already come in from the banking sector, consumer finance, and mortgage companies," notes John Butters, research analyst with Thomson Financial.

And -- most fascinating -- on a rate cut conspiracy theory in Thailand:

The argument goes that consumer price inflation was down on the year to 1.1% in August from 1.7% in July, creating the right conditions for a rate cut alongside relative weakness in Thai securities, which have yet to feel the effects of positive economic growth in the country.

The rate cut would most positively impact home builders and financial stocks, giving what many say is a long-overdue boost to the Thai stock exchange (SET) in general. In the last year, the SET has advanced 37% to 847.93, much less than other regional stock exchanges: in the same period, the Hang Seng has gained 65% to 27,066, the Korean Kopsi is up 54% to 2003.60 and the Shanghai Composite Index has soared 217% to 5552.3

It's going to be an interesting week. I have a feeling that you'll see the SET take off amid all the positive spin on the Thai economy after the BoT meets on Wednesday -- even if it doesn't cut rates (great time to get some exotic SET index futures right now). Wednesday also happens to be the day the official transcripts of the Fed Reserve meting last week is out, which is not going to be as pretty, unfortunately. After last week's uptrend in the Dow, expect some mild nausea from the prop desks in NY. This could be a good time to purchase some put options on the Dow, alongside those SET index futures, and create almost a mirror-image opposite hedge of the one many were playing with back in July 1997.

It's a good emerging market hedge for the following reasons: it concerns two rate-slashing, tame  inflation markets (unlike, say, China or Brazil), one is an export-led economy and the other is an import-led economy, and it takes advantage of all the emerging market growth around. Let's see if you would have been in the green on Friday.

Chasing Beta: Bernanke & Greenspan

Here is a very well-written article about the current US market scenario. Despite my recent bullishness, I have to concede that the Fed's 50 b.p. cut in interest rates was sheer lunacy. The only defense I can think of to support such a cut is that it is just so completely mad that it might actually work. As several commentators have pointed out already, the Fed now has nowhere to go if the going gets tough again. While it's still too early to tell whether this will be the case, it is impossible not to agree with the logic behind Peter Bookvar's (Miller Tabak) statement :

'You don't have a multi-year credit bubble that is over in a couple of months; why the market thinks that is beyond me.'

It's also interesting to see everyone hammering Greenspan right now for having kept rates so low for so long in the 1990's -- as if he is personally responsible for the current volatility. If Greenspan was foolish, then Ben Bernanke looks like a circus jester: giving markets not only a multi-billion cash-fuel throughout the summer, but then topping it all off with a giant, unprecedented rate cut. This is not to criticize Bernanke per se; in many cases he has helped stimulate markets out of a recession which could have been especially difficult to shake off. However, the fact remains, there is always a cost where there is a benefit, and when you stimulate an economy so quickly out of a recession, you get lot of hasty money.

On a further note, it will be interesting to see the consequences if the market does hold up. As I pointed out recently, one potential effect is that speculators increasingly look overseas to the heady emerging markets for record gains:

This recent action in South Asia's derivatives markets looks interesting alongside the ruminations of the supposed global credit crunch. For if there really is a shortage of global liquidity, then why are funds buying ultra high-risk emerging market equity derivatives?

... What appears to be the case is that given the European and U.S. authorities' enormous cash fuels to domestic banks, these banks and funds have started to look for the same kind of gains they were getting from speculating on sub-prime. After all, there is still demand from the hundreds of event-driven funds out there. An obvious contender is emerging market derivatives, which are volatile, but extremely high return. And with emerging market growth soaring this year, the equities possibly look like a good bet.

This would give us almost a mirror-image picture of the 1990's again -- where funds couldn't resist over buying emerging market securities and in turn over-stimulating their currencies, until the whole global system temporarily collapsed. In that instance, it will be much easier to draw parallels between Bernanke and Greenspan than critics of the former chairman of the Federal Reserve may like to admit.

Macro/Micro

Contrary to my comments the other day, it seems that if you have been reading this blog since the beginning of the year, you'd actually have made some decent money (LINK):

And for what it's worth, here's what happens next. The current US economic and market strength will continue at a bullish pace right up until about September/October, when a spew of economic data will show how in Q2 we got just a little ahead ourselves. This, combined with some instability created by a looming election, will prompt some of the big pension funds to throw money back into gold, and it will have a natural, short-term correcting effect for markets (which in all probability probably won't be needed so it's a time to buy then). However, because of this overreaction, we'll probably see that growth re-bound in the final quarter of the year as Q3 fundamentals show everyone that things are actually still in pretty good shape.

And while the Japanese may raise rates, as might China, don't expect too much discipline from the governments of these economies. When Asia has a run, she's usually more afraid of stopping that run too quickly than she is of letting it overheat, so though she might put in a quarter-percent rate hike here or there for show, it's not in keeping with the general ethos of the region, which tends to get a little overexcited about its own economic prospects (usually as a result of knock-on growth from the European region and the U.S.A.) In other words, right now, you want to be buying Japan.

The Nikkei shot up to over 18,000 after that comment was made. Japanese equities look good again right now, with the Nikkei up more than 10% on the month to 16,845.96, and the yen seems to have regained regional stability. And - surprise, surprise - the Dow is back to an all-time high (I said that HERE recently too).

One of the side-effects of globalization is that everyone seems to use Macro- data to judge what are, in effect, Micro- situations, like market movements. It's an information overload problem, and it's not always an accurate way of trying to gauge where stocks are headed.

Truly Diversified?

Farnoosh Torabi this week interviewed TheStreet.com's metals writer Simon Constable about the issue of whether Greenspan is to blame for the sub-prime debacle (by keeping interest rates so low for so long). Constable's answers make for poignant consideration (VIDEO HERE):

There's two things here: first of all, everyone in this episode is seemingly saying, "not me, not this, this isn't my fault, it was the other guy, it was my predecessor, it was my mother, it was my mother-in-law ... but it wasn't me." That seems to be what's happening all over the market and it goes all the way back to Enron. It's been a decade of people blaming each other. However, I talked with some economists this morning and what they're telling me is that it was probably a policy decision on his part to say that it was OK, because even though there were going to be some abuses, we'll keep the economy rolling.

Indeed, this seems to sum up neatly the attitude towards economic fundamentals over the preceding 20 years. There are two economic conditions that have made markets amenable to the sort of volatility we experience these days. The first is the focus on growth, above all else, including but not limited to fundamentals, accounting, and even value. It's for this reason the private equity market has burgeoned so much: a singular focus on driving growth as quickly as possible -- with the least amount of hassle.

Added to this, the mass democratization of capital markets, to include numerous retail speculators who now have access to unprecedented levels of margin and credit stimulates this growth like steroids in a professional athlete.

The new economic climate challenges the meaning of the "diversified portfolio." A lot of financial institutions and market commentators like to promote the concept of such diversified portfolios as a safe way to access economic growth, but in reality when the above two conditions are in full swing, diversification becomes much harder to achieve, to the extent that whatever you're invested in - be it commodities, securities, bonds or real estate - is unavoidably at some level a leveraged bet on  the growth of more speculation.   

Things Are Not What They Seem

How wrong we get it sometimes. Not so long ago, right here at The Global Perspective, I shouted off about how crude was destined for free-fall, about how U.S. markets were a straight buy and how China was a short opportunity just begging to be cashed in on.

With crude at $80 for the first time in history, U.S. markets in relative free-fall in the midst of a giant housing credit crunch, and China's markets and economy surging upwards with an unstoppable velocity, the latter scenario doesn't look so convincing -- to say the least. If I was running money I would have been laid off months ago.

Then again, I have the luxury of not running money -- and not having to make gut decisions on a day-to-day basis based on what everyone else is doing. And best of all, for me at least -- but for others who don't yet know it -- whatever the current market scenario, the fact remains, I'm right. There's more oil in the world than suppliers want you to believe, U.S. corporate fundamentals are actually in pretty good shape, and China's companies are still largely run like Taipan-geared hothouses.

In times of volatility, the first thing people tend to forget are the facts. Before you shoot off a vitriolic e-mail telling me how wrong I've got it, let me throw out here some recent examples to illustrate the point. First of all, for all we keep hearing about the shortage of oil in the world, we seem to see very few actual examples of that shortage. In fact, I can't think of one since the 1970's. Oil may be getting a little pricier on average, but it's not like anyone has been forced to stay at home or walk to the nearest mall recently. It's worth remembering that the two people sounding off about how oil is running dry are the futures and options liquid commodity speculators, and those actually involved in supplying the stuff. In reality, there seems to be so much going around that Venezuela can afford to strike bargain basement deals with the City of London. In a time of a genuine oil shortage, this would not be the case: for a start, the U.S. would be deal-making with the charismatic Venezuelan leader.  (You better believe that if London and Caracas will do a deal together, so would New York and Caracas, given the right demand scenario.)

Secondly, U.S. markets are still way up, on average. Right now, you can't pick up a copy of a newspaper without reading a story about the effects of the U.S. sub-prime chaos on equities, but in reality the two have very little to do with one another fundamentally. The reason U.S. equities plunged as credit spreads tightened is simply that in such a market, holders of credit derivatives and equities alike -- and there are many -- couldn't get rid of their mortgage backs, so logically enough, they sold their equity positions. This only had the net effect of turning up a few bargains in the market. Talk of a U.S. recession is premature, too: by definition, those who have sub-prime loans are hardly major spenders in an economy, and therefore, less significant than say, ordinary mortgage holders. The effects of sub prime defaults have been sad to see on a human level -- which is largely why they are all over the papers -- but hardly very significant on a global economic one.

And where China is concerned, the warning sign came for me the other day. "Chinese stocks are a great hedge against global equities, because while global equities have been going down, stocks in Shanghai have been soaring," I overheard someone say the other day. When people start talking of hierarchal Asian growth-stocks as a hedge against huge, stable, flat, industrial organizations with 50+ years of documented accounting behind them, you generally know you're in a bubble.

Right now you're better off not buying a newspaper, or reading a wire report, for that matter. Because the reality is, most of us have become so wrapped up in a human-interest and political argument, we've temporarily lost our economic marbles. Not for the first time, things are not what they seem.   

Dow Passes 13,000

After a rocky start to the year, the Dow Jones Industrial Average has now passed the 13,000 benchmark:

The last few months have been a somewhat rocky ride for the Nasdaq too, but now the index is hitting something close to a five-year high:

I am reminded of what I said about GDP and the knock-on market effect back in November:

America needs to stop worrying about productivity, and start worrying about what to do with all the productivity when it comes about in the next three or so years, or it may find itself back in an enormous bubble. This is what happened in the late 1990's; productivity materialised, but was fed into productively non-existent assets, which killed the productivity cycle.

Either way, another bull market is coming.

Now, everyone's talking about that bubble. I've heard this from some respectable sources, but personally I don't buy into it: the dynamics of global risk appetite (i.e. extra liquid capital from different areas of the world lying around ready to be mopped up) mean this kind of analysis is premature. Rather, we're at the beginning of something.

China Rate Hikes

After yesterday's cautious comments on China's economy by Premier Wen Jiabao, China is raising rates:

China's central bank said Saturday it will raise interest rates in an effort to rein in the country's red-hot economy, according to published reports.

The People's Bank of China will raise rates 27 basis points, lifting the benchmark one-year lending rate to 6.39% and the one-year deposit rate to 2.79%. The changes will take effect Sunday.

More context here (Reuters):

The yuan has now appreciated about 4.8 percent against the dollar since Beijing revalued it by 2.1 percent and set it free from a dollar peg to float within managed bands in July 2005. It touched a post-revaluation high on Friday.

But many economists say the only way to close off the tap of liquidity at the source is to let the yuan strengthen even more so as to make Chinese exports more expensive.

That would help ease the swelling trade surplus, which hit a near-record $23.76 billion in February, far more than expected.

The central bank, in an effort to keep the yuan stable, buys most of the dollars generated by the surplus, for which it must in turn print yuan, thus flooding the banking system with cash.

Gao Shanwen, chief economist at Everbright Securities in Shanghai, said he thought the interest rate rise would only exacerbate that problem.

"Higher interest rate rises can help slow down investment and domestic consumption. With domestic consumption weakening, more and more goods would have no market at home and have to be exported abroad, which would make the trade surplus even larger," Gao said.

Gao has a point: many skyscrapers, consumer goods etc. are made on the premise that consumption will grow sufficiently over the coming year to fulfill orders and demand in the future. If consumption comes off, then this means exports play an increasingly important role in the growth of China's economy. That means you need a very strong U.S. economy to swallow up the excess consumption which cannot be provided for at home, as well as an increased addition of foreign investment to keep those new skyscrapers full.

The effects a rate hike like this - and future rate hikes - may have on global commodity prices will be interesting to see. I pointed out this week that steel may become a lay casualty (for the above reasons), while also pointing to pending rate hikes in China and India, and the consequences of such (Steel & The Carry Trade: Reflexive Market Duality).

Further notable commentary from Aaron Task today at thestreet.com too over next week's implications (Coming Week: Spotlight On Central Banks):

In the wildcard department, Chinese Premier Wen Jiabao made some eye-opening comments Friday, characterizing his country's growth as "unstable, imbalanced, uncoordinated and unsustainable," Bloomberg reported.

The reaction to Wen's comments was notably muted Friday, which may suggest Asian markets' late-February rout was an isolated event. But similar to the time the premier's Chinese New Year holiday declaration about corruption and fraud spurred those massive losses in Shanghai, investors will have two days to mull Wen's latest comments, as detailed here.

In addition to any postmull reaction to Wen's warnings and the subsequent rate hike by the People's Bank of China Saturday, Monday is also the first day of a two-day BOJ policy meeting. Japan's central bank is largely expected to keep rates unchanged at 0.5%. But any comments about future rate hikes could revive fears of an unwinding of the yen carry trade -- or even actual unwinding of trades made by borrowing yen to finance investments in high-yielding securities around the world.

Summary: Markets in Asia Monday/Tuesday (and knock-on effects on the Dow) will be notable.

China's Premier: Growth "Too High"

China's Premier goes on record today in Beijing about unsustainable growth in the country:

March 16 (Bloomberg) -- China's economic expansion, the source of about a 10th of global growth last year, is unstable and environmentally unsustainable, Premier Wen Jiabao said.       

``China's investment growth is too high, lending growth too fast, liquidity excessive and trade and international payments very imbalanced,'' Wen said at a press conference in Beijing today. Energy efficiency and environmental protection issues haven't been ``properly resolved,'' he said.                

Wen's comments underscore government concern that too many factories are being built in China, worsening pollution and leaving the world's fastest-growing major economy vulnerable to a slowdown in demand. A record $177.5 billion trade surplus has flooded the economy with cash, making it harder for the government to cool investment by reining in bank lending.      

``China has maintained relatively steady and fast growth over the past few years, but this is not a time for complacency,'' Wen told reporters at the National People's Congress meeting. ``The biggest problem in China's economy is that the growth is unstable, imbalanced, uncoordinated and unsustainable.'

This is very big news, and effectively amounts to an admittance that the next growth revisions we will probably see for the country will be around 8 - 9%. While this is still strong, it will have wide-ranging impacts for demand in commodities in particular, to growth in the south east Asian region.

The reaction by Chinese markets however seems small: just a dip of 0.72% in the Shanghai  Composite Index to 2930.48, barely a blink from the Hang Seng, down 0.08% at 18,953.50, and even the heavily leveraged and volatile B-share index in China is off just 1.36% to finish the week at 170.21. There is almost certainly bigger declines headed for Monday/Tuesday, especially if the sub-prime fiasco in the U.S. continues to make waves across the world over revised import trends.

*UPDATE* 12.04 pm Further context at thestreet.com where I'm looking at this situation in more detail (Another Shot Across Asia's Bow):

In Hong Kong, investors were speculating over the potential effects of the debacle surrounding subprime mortgages in the U.S. and revisiting the importance of the yen carry trade -- the borrowing of yen to finance investment in higher-yielding assets elsewhere. The broadest consensus is that the subprime mortgage deterioration, despite constituting less than 10% of America's mortgages, will prompt banks to tighten credit standards. That could undermine U.S. consumer spending and prove a drag on Asian exports.

Chisato Haganuma, a senior Japan strategist for Nomura Bank in Hong Kong, says Asian exports -- a crucial source of income to the region -- will "soften considerably" and that the second-quarter outlook for the region is "gloomy".

Just as appetites for risk were starting to normalize again, fears that the U.S. subprime dilemma may have a further destabilizing impact on exports are prompting renewed concerns about an unwinding of the carry trade.

Steel (& The Carry Trade): Reflexive Market Duality

Over at thestreet.com today, I'm taking a look at the potential impacts of the recent Asian emerging market mayhem on the price of steel, and what this says for the global economy (Steel Could Be the Next Victim):

Steel's bulls and bears do agree that global interest rate hikes are coming. If the price of steel continues to climb, then a large segment of manufacturing becomes more expensive, potentially resulting in higher consumer price inflation as producers seek to pass along the price hikes. But those who see the price of steel as already overvalued also see this as a consequence of overheated emerging-market economies, which are overdue for interest rate hikes.

"Both China and India have not raised interest rates sufficiently to cool their economies, while infrastructure project demand is still germinating," says Darby.

Furthermore, if global rate hikes are afoot, growth of emerging-market economies would slow, pushing the price of steel down as oversupply in these economies materializes.

It's kind of a rate hike Catch-22, with steel caught right in the middle as both a product and casualty of volatility in consumption, and hence global markets. I would say at this stage steel is in the process of going from becoming a tool by which you can gage market reactions to one which is driving certain market reactions, especially in duality with the yen carry trade. The problem is, it's also - just like the carry trade - reacting to market reactions as well, creating a reflexive tension (and this is why you're seeing so much volatility right now, with the Dow swinging wildly below the 12,000 level intraday for the first time since December today).

More on the carry trade later.

Japan is still strong

Remember what I said about the Nikkei being a buying opportunity?

This is one reason why: Japan's Economy Grows at Fastest Pace in Three Years (Bloomberg):

March 12 (Bloomberg) -- Japan's economy expanded 5.5 percent in the fourth quarter, the fastest pace in three years, as surging exports prompted companies to increase spending on factories and machinery.         

Growth in the world's second-largest economy exceeded the government's initial 4.8 percent estimate in the three months ended Dec. 31, the Cabinet Office said today in Tokyo. The result was more than the 5.1 percent median forecast of 23 economists surveyed by Bloomberg News.         

``Japan's economy is solid and will keep expanding, driven by a solid corporate sector,'' said Takuji Aida, chief economist for Japan at Barclays Capital in Tokyo. ``The economy is likely to exceed at least its potential growth rate of 1.8 percent in the first quarter.''

I will get around to expounding the Japanese argument, but suffice it to say for now this is a great zone for foreign investment, principally because it's a great bridge between Chinese and U.S. growth.

It's the economy most of us have been longing for - pretty stable U.S-style fundamentals (especially given that lots of the accounting discrepancies have been ironed out since the early-90's debacle) with immediate access to Asia's boom-bust market sex-appeal.

India's 36 Billionaires & The Billion With Just $36

This has to be the most naive piece of propaganda-masquerading-as-financial-journalism I've seen in a long time:

Beijing, Mar 11: Indians topping Forbes' list of Asian billionaires, replacing the Japanese, have flabbergasted the Chinese, who are regularly reading that India is not shining as reported by the Western media and experts.

"I am surprised that Indians have topped the Forbes' list of Asian billionaires," Chen Yu, a media consultant said.

"I must change my distorted impressions about India," she said.

With 36 of its citizens worth over a billion dollars, India replaced Japan as Asia's top breeding ground for the super-rich, the Forbes 2007 listing of billionaires said this week.

Amongst the top dozen Asian billionaires, there were eight Indians led by steel baron, L N Mittal. Asia added 54 new billionaires in the last one year, 14 of which were from India. In other words, every fourth new Asian billionaire was from India.

Compared to the impressive performance by Indian entrepreneurs, the only mainland Chinese to figure among the top 70 richest amongst Asians was Yan Cheung, the self-made woman entrepreneur of Nine Dragon Paper Co, who is the richest in China.

Unfortunately, the assumptions made herein are all too often made by people lacking understanding in what constitutes a successful economic environment, but it makes a good point about the often forgotten ingredients of capitalism.

It's often assumed that the richer the people in an economy, the more impressive it is. In fact, more often than not, nothing could be further from the truth.

Here is what the message of the article really reads: compared to India, China resembles a hub of stability and economic growth (this alone should sound warning signals to those thinking of investing in India right now too). Because when you have a country with piss-poor infrastructure development, more than 80% of the entire country living below the international poverty line, and weakly power outages, all having the highest number of billionaires in the region says is that compounded to these problems, you have an enormous wealth distribution problem, where a disproportionate amount of capital is concentrated within a very thin slice of your society.

One of the criticisms most of often lobbed at a system of open-markets is the inherent inequality such a system creates, but in reality nothing could be further from the truth. It's the reason economies like the U.S.A. and the U.K. are, for example, stronger and more stable than say, the Chinese or the Indian economies. The fact is, in order to have an efficient market system, with long-term sustainable growth created by constant re-investment and spending, the ideal system is one in which more people have more-or-less the same reasonable level of capital available to them, rather than one where a slice of society owns everything. This is only logical: the more market actors, the broader the spread of investment and spending in an economy.

This article is also a a great example of another often-made mistake by even quite senior market analysts: that you can use the same comparables for emerging markets as you can for developed countries. The reason it's impressive when an economy such as the United States' announces the number of billionaires has increased is that proportionately speaking, there's a pretty good spread of the wealth in the economy already, so the number generally indicates a surge in entrepreneurial activity prompted by aggressive capital markets. In India, where one billion people would be happy with $36, 36 billionaires is quite another story altogether.

By advertising that despite shaky capital markets, inefficient transportation, loose power lines (and that's being generous), 75% of her female population currently completely illiterate, India has the highest number of billionaires in Asia, the country only serves to re-enforce the risks and inefficiency in her economy. That's not to wipe India off the emerging markets watch-list, but it is a red light.

U.S.A. & China

Anyone following the performance of the Asian markets this week can be forgiven for feeling a little uncertain about what's going on right now. On Tuesday, the Shanghai stock exchange tanked nearly 9%, bringing the Dow Jones down 415 points with it and making news across the world, the next day it rebounded 3.9%, Thursday the market slumped again nearly 3% and in today's trading it inched up 1.23% again. Tarrying the performance with other markets in Asia only leaves one more confused: on Wednesday when China was strong, the Hang Seng and the Nikkei continued their spiral in the other direction. Only the past two days have we seen some kind of conformity in Hong Kong and China's market performance, but it's safe to say that by and large results are mixed, and even then, as these markets have finally regained a small footing (the Hang Seng ended the day up 95.41 points yesterday at 19,442.01), Japan fell further today and at the time of writing the Dow is trading down 75 points at 12.159.44.

While all this is a volatility trader's reprise for the several months of straight vertical performance we've had in world markets, it doesn't say much about what's to come for the majority of us.

First of all, while there may seem like a general feeling right now that things are not good for markets, this is a gross over-simplification of what's going on, so I'll explain the general arguments and then then I'll give my take.

In China, the most widely-touted argument going around right now is that while market performance is uncertain and stocks may be overbought, the underlying economic growth of the country is actually pretty strong. In other words, keep buying into China and doing deals there, just stay away from the Shanghai and other regional stock exchanges right now. This has to be the most misleading piece of economic propaganda I've heard come out of the region in a long time. Just relate it to the argument being made about the U.S.A and you'll realize it makes no sense at all.

In America, the argument is that the economic performance of the country is slowing down, and so markets too don't look such an attractive bet right now. The U.S. global goods report released last week, indicating that perhaps we'd all just got a little ahead of ourselves with our positive forecasts, was in part responsible for the big reaction on Tuesday, and this type of data is still having an impact on the shelling spree we are seeing in the Dow, the NASDAQ and the S&P. In fact what we are seeing in the markets now is exactly the type of scenario I predicted we would see in Q3, it just came earlier than expected. This makes sense given the Asia context too, which many forecast as inevitable but "earlier than expected".

The point is, you don't get strong economic growth and slumping markets in an open economy - at least not for long, because such disparities contradict one of the most fundamental principles of macro-economics: that if there's a buying opportunity, someone will see it and snap it up. In other words, if it was possible that you could have a booming domestic economy with weak domestic markets, it wouldn't be for a very long period because it would be an enormous arbitrage opportunity that everyone would see and buy into until markets reflected economic performance, and the situation returned to parity.

So, if China's economy is still booming and America's is falling apart at the heels we should seize this opportunity to buy China and go along with all the bears in the U.S. and sell the Dow, right? Completely wrong, and here the argument gets slighty more complex. Once a market is established in a country as a primary force of capital entry and exit, that economy in which the market operates is to a large degree affected by that market's performance, with little abstractions. Remember the period 1996 - 2000? U.S. markets were surging upwards, and the economy followed. Business was created, companies had more capital to play with, and everyone by and large got richer; if they didn't actually get any richer they at least felt richer (i.e. that an opportunity was 'just around the corner') and they spent more, meaning business got richer again.

What China has done over the past few years is viciously promote its own domestic markets - sometimes to the point where she declared she had no need for U.S. capital since her domestic markets were flush with cash - and as a result, China has come to resemble a typical open market-based economy. Now, what happens to a market-based economy when it's way overbought? You can answer that question by looking at the United States in either 1929 or 1999/2000. The market spirals, and all the processes described above during that period go into reverse.

Here's a practical example. Let's say a year ago someone came to you with a hot new Chinese company idea and said "we're raising $50 million right now, do you want in?" You'd be stupid not to say yes. And what about if the same thing happened today? You'd be more hesitant, and so would everyone else, which means either the capital needed to start the company wouldn't materialize and it would never get off the ground, or that it would take longer to materialize and it would be delayed. Which means either no more jobs created by the new company or jobs created by the new company would come open later. The point is, either situation doesn't encourage faster, and deeper economic growth.

By taking such enormous state-owned companies like the big banks and industrials to market with such a fanfare, China has pegged her economy to the market, and what we are seeing now and about to see is the first example. Her economy is far more led by her local markets than people are willing to let on right now, or even realize. Just because the country is far away and has a billion plus people, it does not mean her economy works differently. A market-based economy is a market-based economy.

Now, in the U.S., we've all forgotten that even a year ago markets were way, way underbought given economic performance, so right now, that doesn't necessarily mean they are overbought. And they're not. The next few weeks will be a fun time for value traders to pick up some cheap deals which were just about looking like they were going to get too expensive quickly. And the economic data isn't that bad. It just says that the U.S. is a huge economy, and it takes time for huge things to grow (i.e. they don't grow at the same pace as they do in the much smaller emerging economies).

This is why my consensus is distinctly for now: buy U.S., sell China. It's not the end for China, but it is a longer term problem than people are making it out to be. And that's a healthy thing, because it shows how far the country has come on in resembling a fully-functioning open market society.    

China crisis: latest

The latest breaking news from China: China could get worse:

A day after shares in China plunged 8.8%, shares on the Shangahi Stock Exchange rebounded, with the index ending the day up 3.9% at 2,881.07.

But investors in Hong Kong say that the worst is still yet to come, and that the outlook for China's market remains overly optimistic. The Hang Seng ended the day down 2.46% at 19,651.51.

"Equities in China are still much more overpriced than people are admitting at the moment," says Sean Darby, head of Asian strategy at Nomura Bank in Hong Kong. "The Chinese pressure cooker is getting hotter. It hasn't tightened rates that much. There's closed capital account money flowing in and contracting liquidity."

The article is hot off the press from last night EST. I should mention that I wrote it.

Consensus: we are seeing the beginning of a south Asian contagion, though Hong Kong and Japanese markets are unlikely to be affected long-term. More context to follow.

China: it was coming

I have to say, I saw China's steep decline coming at the beginning of the year:

Doubts over the sustainability of last year's boom raise the question of whether 2007 is the next 1997, when Thailand's currency devaluation sparked the so-called Asian contagion: bouts of panic-selling in Asian markets that spilled over into other emerging markets and, eventually, developing ones as well.

"What's often forgotten, I think, is that the way we correlate risk in Asia is very high," says Sean Darby, head of Asian strategy at Nomura Holdings in Hong Kong. "We're almost certainly due for a correction this year."

By tomorrow, we'll all have a clearer idea of how far the Chinese market declines are headed: will blog more. Meanwhile, the article helps explain some of the reasons for the decline.

Market Direction & Portfolio Positioning

Sundays are usually pretty quiet, and generally consist of a little preparing of things to do for the coming week, a few coffees at the great Italian coffee shop over the road from my apartment in the East Village where I live in Manhattan while reading the news and some research reports, culminating in four hours or so of Law & Order re-runs on the couch after lunch.

Not so this Sunday. A ton of work awaits me this week - several stories, papers, a video-story (more on this another time) and two overdue chapters of a novel - all of which needed attention, my Dad flew into NY on business, and graciously, thousands of new readers decided to stop by for a casual weekend post I'd written on Saturday about mistakes Europeans make when they're in the U.S.A. In total, there were 73 comments by the end of the day on the post.

I have said here before that hearing from readers is one of the principle reasons I write this blog, and I believe passionately that it's the key concept at the heart of journalism and the arts for that matter too. As my grandfather once told me, "you can have the most talented opera singer on the stage, and the most splendid orchestra behind her, but what are they without an audience? Quite."

So I want to kick this week off by focusing on a comment made on this blog by a reader called Don, as a response to a post I wrote on Friday called "What Does This Mean?" The post concerned the nature of business news, and specifically what kind of business news was useful for investment decision making and what kind was useless, with some general outlines on how to identify the former from the latter to enable clearer - and better - investment choices. Don had this to say in response:

While there are thousands and thousands of opinions on the market in general (and they are best ignored), there are only two behaviors...buying and selling. We seek these so called expert opinions because they provide a level of comfort in an uncertain world, especially if the opinions match the way our portfolio is arranged. Personally, I would rather have my portfiolio set up to match the behavior of market participants. Right now the buyers are in charge, so I stay long. When that changes, so do I.

I find several things particularly interesting about this comment. First of all, it represents the belief and behavior of lots of market participants at the same time as being the very belief and behavior that others abhor, in particular the  so called "experts" who always parrot the same piece of obvious wisdom, "buy cheap, sell high". Secondly, it is a strategy that has in part made some enormous amounts of money, and lost others nearly, or maybe all of their portfolio. In fact, it's the same kind of thinking which has brought down numerous hedge funds, most recently Amaranth and Latitude.

The biggest issue with the strategy is that although it doesn't look like it, it is in fact very high risk, because you are trying to engage in a guessing game without any reference to the fundamental state of the market or assets you are investing in. But still, that doesn't mean you can't make lots of money doing it. It is a perfect illustration of John Maynard Keynes' anecdote of the market being like a beauty contest with the grand prize of £10,000 for the reader who could spot the "prettiest girl". Instead of spending time choosing who one thinks is genuinely the prettiest girl, argued Keynes, the readers would instead be wondering who others think is the "prettiest girl". The problem is, when the market turns against you, it can often be harder than the comment makes clear to see that happening (like oil companies right now). But with lots of people in the market thinking the same way as reader Don, such a mentality becomes impossible to ignore, because it in fact impacts the direction of the market.

I think ultimately a portfolio is best divided between a slice of momentum and a a slice of fundamental; that is, by all means take positions in the current market direction, but also don't be afraid to compliment that with sound bets which look right to you, no matter what the market thinks. Most of the advice and news you read on this blog will be the latter kind, incidentally, because I'm a great contrarian, and I believe in looking the other way for maximum profit. Still, no matter how brilliant your fundamental and technical analysis, like the opera singer who needs an audience, you always need market momentum behind you, or all the greatest analyses in the world won't help. When what you think are great portfolio stocks aren't performing, that means taking a commercial stance at some point too, and recognizing your analysis is sometimes just not in line with what everyone is thinking.

"Timing" is to the market what "location" is to the real estate sector.

Nikkei 30,000?

The other day I made the point here that the Japanese were not likely to raise rates much by much more than a quarter-percent any time soon, since they were long-overdue a bull-run which has just got started, and were probably more concerned about stopping that run in its tracks than letting it oversell itself.

Justin Urquhart-Stewart, Director of Seven Investment Management and writing at the London Stock Exchange, makes a noteworthy observation about the potential rate hike in the Japanese economy:

What I find far more interesting is the expected impact of what such a small rise might have domestically in Japan. In the UK if rates rise we quite rightly fret about the impact on peoples’ borrowing and the increase in mortgage payments, as well as the effect on the vital level of consumer spending.

Not so in Japan. It has been estimated that a 0.25% rate hike could increase household income by 1.1 Trillion Yen (around £233 billion!) which is an approximate increase of 0.4% in household income. This in turn could further support consumer expenditure and consequently provide a timely fillip for the vital but struggling retail side of the economy. How quirky does this seem when compared to our heavily indebted consumer society? In Japan the growing army of actual and would-be pensioners have been saving their hard earned cash and, since the start of the depression in the early nineties, have veered away from the financial maelstroms of the Japanese property and stock markets. So an extra “bip” on the deposit rate can have a marked impact.

From an American or European standpoint, it's strange to imagine a world in which interest rate hikes mean good news for everyone, but when the majority of people are debt-free with cash in the bank, it pays off.

Most notably however, the observation re-enforces my previous point about buying Japanese equity at this level. This is because a rate-hike will make everyone in Japan feel little bit richer, as well as a little more secure about domestic growth prospects, and when we all feel that way, we tend to spend more and take more risks; in investment terms, the latter means we move from cash to equity positions.

Added to the prospect that the Japanese will keep the new 0.5% rate flat for quite some time, and you have a pretty perfect 2-year equity bull-run in place. With the Nikkei 225 at 18,188.42, it's catching up fast with the crucial 20,000 mark - having grown by 22.8% in the last year - but still a long way off from the time in the early 1990's when it topped 40,000, which is exactly where you want a market to be when you're buying aggressively: right in the middle with a competitive but not irresponsible upward growth curve.

In fact, I would say that the Nikkei 225 could well reach 30,000 within the next 12 months. Sound ridiculous? Think how ridiculous the phrase Dow 13,000 sounded only six months ago. In the right economic environment, markets often take off far quicker than anyone expects.

"What Does This Mean?"

Earlier today, I was talking to a good friend of mine who was wondering what do with her portfolio and she complained that she was further non-plussed by all the media coverage of stocks. Reading the financial news, I have a lot of sympathy for anyone with the job of actively managing money for a living or for their personal account, so I'll try and help out a little with what type of news piece to read and what not to read. Take a look at these two articles about exactly the same event - the oil price movement - this morning. One is from Marketwatch, while the other is from AP. The reason I pick out these two news organizations is not absolutely random either: Marketwatch is owned by Dow Jones, and the DJ people tend to work very closely with AP journalists. In a lot of bureaus, they actually share the same office, and in most, they share the same building.

Here are the lead and second paragraphs of both articles:

Marketwatch:
Crude erases 2007 losses as data extends rally
Larger-than-expected supply decline sends futures as high as $61.80 a barrel
NEW YORK (MarketWatch) -- Crude-oil futures extended their rally Friday, pushing the front-month contract into the black for the year, in a continued response to data showing a far bigger-than-expected decline in heating fuel during last week's bitterly cold snap, reducing unusually high stockpiles following a mild winter.
Oil also got a boost after some geopolitical flare-ups: Iran defied United Nations demands that it stop enriching uranium, and traders got jitters amid fresh violence in Nigeria's oil-rich Niger Delta region.

AP:
Oil Trading Slow on U.S. Inventory Drop
Oil trading slow as market reacts to surprising drop in U.S. gasoline, heating oil inventories
Oil trading was slow Friday as the market adjusted to a surprising drop in U.S. gasoline and heating oil inventories.
Light, sweet crude for April delivery nudged just 1 cent higher to $60.96 in light electronic trading on the New York Mercantile Exchange, midafternoon in Singapore.

Just for the record, this is bad business journalism in both cases. I hardly need to point out that one can infer completely different scenarios from these two articles about the movement of the oil price. This type of mistake is usually down to a failure of business journalists being educated in the subject they are writing about; namely, business. Both articles miss completely the main paragraph, too, as a result: what I call the "what does this mean?" graph. If you like, it's the "where should I trade?" explanation part of the article. An article is only as useful as a chart if there is no paragraph telling the reader what the news being reported means, and this is in almost every case the giveaway of the difference between business journalism written by someone who really understands what is going on and someone who doesn't quite get it.

A person who can tell you what something means understands the topic they are writing/speaking about, whereas someone who cannot does not. In the case of both these articles, the "what does this mean?" part of the story is side-stepped by inferring whether this is good or bad news into the headline, which is also a classic mistake (to be fair to the Marketwatch piece, there is a sort-of-meaning in the seventh paragraph, but it doesn't relate to the headline very well). A headline does not tell you what something means - it tells you what's going on. (Incidentally, this is not a comment about Dow Jones and Marketwatch, both of which are usually very reliable, although reading business news from the AP is almost always completely misleading, as I have pointed out before).

Now, the same story by Bloomberg:

Oil Is Little Changed After Rising on Fuel Supply, Iran Threat
By Eduard Gismatullin    
Oil traded little changed in New York after rising to the highest price this year after U.S. fuel inventories plunged and analysts said supplies may be disrupted if Iran is sanctioned again for developing nuclear capabilities.
U.S. stockpiles of distillates, including heating oil and diesel, fell 5 million barrels last week, or 3.8 percent, the biggest drop since September 2005, according to the Energy Department. The U.S. and European nations will meet next week to draft a second sanctions resolution against Iran, the second- largest Organization of Petroleum Exporting Countries producer.

Definitely less sensational, but it summarizes the complexity and ambiguity of what's going on really well, without jumping to a conclusion before all the facts have been laid out. Then, succinctly, follows the "what does this mean?" graph:

``The main risk to the oil price is either a boycott of trade, isolating Iran, or a military attack,'' because either would ``influence the production and supply of oil from Iran to the world market,'' said Thina Saltvedt, an analyst at Nordea Bank AB in Oslo. Distillate inventories ``will influence the price'' until winter ends in the Northern Hemisphere, she said.         

This gives a meaning to the story - the global supply-chain with specific emphasis on Iran - and a time-line, namely, when winter ends in the Northern Hemisphere. Now that's news you can use.

Private To Public In 30 Seconds

John Neshiem has a revealing post up about venture capital:

Today I had tea in a quaint hotel in Carmel with an experienced investment banker from Hong Kong. Educated at a top American university, and quite professional, he was immediately impressive. He was interested in what the differences were between "private equity" and "venture capital".

I labored to explain it to him, but was not getting through.

Then he asked if he could tell me about an idea he had come up with for a startup. After he described it, I knew what to tell him.

He took about five minutes to describe his idea.

A venture capitalist can do it in 30 seconds.

That is the difference between a banker and a VC.

The fact that bankers are already -albeit unconsciously maybe - starting to wed the concepts of venture capital and private equity together says some very interesting things about what's to come in the private equity market.

This story also illustrates quite well the confusion - and the extent to which the confusion runs (up to the level of senior bankers) - over the concept of private equity. I encounter this confusion the whole time. So first, for those similarly baffled by the concepts of private equity and venture capital, venture capital is a means of financing a project while private equity is a type of business model. If I have an idea, and you're willing to give me $5 million for a stake in the company I'm starting up to carry out that idea, that's venture capital, and you become a venture capitalist. Now, there are two principal business models we can adopt in running the new company: either we can plan to list it on a market like the NASDAQ, in which case we're going to be running a public company, or we can plan to keep it private, in which case it's private equity.

Now consider that right now, the fad is in private equity. To be fair, it's easy to see why. You don't have to answer to lots of little shareholders, you don't have to file anything like the number of reports you do if you run a public company, and specifically you don't have to hold lots of meetings and announce what you're doing to the public every time you want to do something big like buy another company. With the tightening of regulations on listed companies over the last five years, the private equity model has become extremely attractive to lots of investors. One very senior PE dealmaker told me the other day that he sees the private equity boom continuing for at least another three to four years.

I don't doubt the mid-term buoyancy of the PE market, but there's a grand misconception right now that the private equity boom is self-sustaining. It's not, and it can't be. The reason is that capital has to find an outlet somewhere along the money-train.

It's worth looking back for a minute. Private equity today is very different from private equity in the days of the dot-com boom, when an investor made a private investment on the expectation of a rapid flotation. Here, the exit strategy was in cashing in your shares once other punters had bid them up several times over in price. Two or there years back the exit strategy was in a trade sale, like for the founders of YouTube, where you cashed in your chips in a share or cash payment (usually a combination of both) by a big company like Google. But today, as this story illustrates, there's no discussion of an exit strategy: private equity is just seen as a good thing to be in per se. That means that the only kind of financial reward you can expect from the business model is a substantial dividend payment. While this may all well and good - after all, it's the traditional method of running a business - the one-off monster sales of private equity companies create expectations of enormous returns by investors in private equity.

This is where the story is so poignant as a prophecy of things to come in the private equity field. The venture capital position immediately assumes a sale at some point. Without a sale of some kind, the type of quick turn-around big-return investments that investment bankers love to juice their balance sheets - and bonuses - are practically unachievable, and there are only so many companies the size of Google who can afford to buy a private start-up for $2 billion. So where's the next step? Obviously, the markets.

So, once the investment bankers who are getting in on all the action now discover that they can't sell all their private equity in the form of a trade sale, they'll be quick to push it onto the market. Some clever salesman will probably even bill it a private equity IPO', which makes no sense but will appeal to market punters nonetheless. The problem is, the true gems will obviously have been snapped up already by the Googles/Blackstones, so what comes to market will be more dubious-looking. If you think this is unlikely, look at Neisheim's comment again on what you have to do to make a successful pitch in the VC market: you have to do it in 30 seconds! How many of us can spot a truly great idea in 30 seconds? Does Warren Buffett look at a company for that amount of time before giving it the yay or nay? That's just about long enough the glance the cover of an annual report, and it's about as effective. Nesheim is right of course about the process, but it's the process itself that's so indicative of things to come.

It's the classic type of situation which creates a boom which quickly materializes into a bubble, with all the classic characteristics of a bubble too: distorting the original intent and business concept of the liquid that's keeping it together.

For What It's Worth

I wonder whether anyone still remembers all the fear surrounding the US economy in the last quarter of 2006? The doomsayers were predicting a never-ending hike in oil and gas prices, prompted by, among other reasons, Venezuela or Iran turning off the taps, political tension in the middle east, increased consumption: you name it, there was a reason. I remember, much to my frustration at the time, when I was trying to write an article with the premise that big declines in the oil price were almost a certainty, and I couldn't find an analyst who would say the oil price was due for a fall. It was at that point I knew the price was coming down: if there's one rule in the market, it is never say never, and when everyone is saying never, go the other way.

The other concern was GDP. I pointed out back then that too that it was in fact a healthy sign for the economy that GDP was down, because when you correlate this figure with private investment, they are pretty much inversely related right before a big bull run, after which they return to parity with one another as dividends and investment pays off in productivity.

The situation today?

Oil is at $58, and falling, the Dow is at 12,786.64 and the Nasdaq is pushing the crucial 2,500 mark by about 13 points. And what about GDP? Well, here's an indication:

LONDON (Dow Jones)--Economic growth in 30 of the world's richest countries stepped up a gear in the fourth quarter of 2006, thanks to buoyant activity in the euro zone, Japan and the U.S.

... The U.S. continued to account for the largest share of OECD (Organization for Economic Cooperation and Development) growth, contributing 1.2 percentage points to the 3.3% annual growth rate.

And for what it's worth, here's what happens next. The current US economic and market strength will continue at a bullish pace right up until about September/October, when a spew of economic data will show how in Q2 we got just a little ahead ourselves. This, combined with some instability created by a looming election, will prompt some of the big pension funds to throw money back into gold, and it will have a natural, short-term correcting effect for markets (which in all probability probably won't be needed so it's a time to buy then). However, because of this overreaction, we'll probably see that growth re-bound in the final quarter of the year as Q3 fundamentals show everyone that things are actually still in pretty good shape.

And while the Japanese may raise rates, as might China, don't expect too much discipline from the governments of these economies. When Asia has a run, she's usually more afraid of stopping that run too quickly than she is of letting it overheat, so though she might put in a quarter-percent rate hike here or there for show, it's not in keeping with the general ethos of the region, which tends to get a little overexcited about its own economic prospects (usually as a result of knock-on growth from the European region and the U.S.A.) In other words, right now, you want to be buying Japan.

Some more news on Hong Kong tomorrow.

Financial Journalists, Hedge Fund Managers, Corporate Jets & The Information Game

One of the most regular e-mails I seem to get from readers of this blog goes something like, "I really enjoy reading your blog, and you write really well. Out of interest, what do you do?"

The praise is flattering, but most of all hearing from your readers is one of the principle reasons I enjoy writing this blog; from software developers to consultants to CEO's to journalists, every one has a unique story to tell and a unique perspective to share regardless of whether they agree with what you have to say or not. Debate is what stimulates the ever-elusive search for the hard truth of economic and political reality, and it's one of the main reasons I write, so I'm flattered to hear from so many who are so curious about what I have to say here.

In order to set the record straight then, I'm a financial journalist; that is, I write about markets, business, the global economy and economic shenanigans the world over. Unlike many in financial journalism, however, I didn't come to the task from a journalistic background, but from a financial one; prior to writing professionally, I worked in corporate finance. "Why on earth," many ask (perhaps fairly) "would you leave finance to join an industry seemingly in perpetual decline, monopolized by lay-offs and low-pay?" Answer one: I love it, and writing/researching is what I've always loved doing. At the end of my tenure in corporate finance, I spent most of my time gravitating towards this end of occupational activity than towards raising capital, which is what I was actually employed to do. Answer two: I'm a born contrarian, and I love risk.

It's in thinking about my own career transformation that I realize a fundamental aspect to the general understanding about the industries I have worked in/work in now is continually misunderstood and misconstrued.

Suffice it to say that the premise of this post then centers around a key idea: that the transferable skill sets and goal sets between financial journalism and money management are large. The argument, in my view, has important consequences - and answers - for the debate which has been rearing it's head over the Maria Bartiromo-Citi-corporate-jet-affair; namely, the ethics of financial journalism.

Managing Information

Perhaps due to the monstrous gap in the lifestyle standards between hedge fund managers and financial journalists, it's not often you hear the parallel between the two professions made, but there are in fact more similarities between the job and goal functions than most realize. Specifically, the two jobs focus on one key theme: managing information. As a hedge fund manager, before you begin to manage any money, you have to get your head around the information that's going to make you any money. Central to that process is the ability to be able to see patters and consequences as a result of those patters where others cannot see them. The same is true of financial journalism: if you want to sell popular and meaningful stories, you have to be able to see patterns and consequences before anyone else sees them. This primary ability is central to distinguishing a hedge fund manager from an analyst at a fund, or a financial journalist from a desk researcher. It requires being as truthful to the information at hand as one can possibly and reasonably be, at the same time as being able to judge that the information is consistent with the thesis you set out to research.

Here's a rather simplistic example, but it illustrates the point I'm making well. Let's say you're a hedge fund manager and you have a feeling that there's going to be a major wave of M&A activity in the oil and gas industry over the next year. As a result, you want to lay some large call (buy) contracts on the smaller oil and gas companies, which you think will benefit from the M&A activity, and some equally big put (sell) contracts on the larger oil and gas firms, which you think will be doing the buying and hence punished by the market (when there's a merger or an acquisition, the company that shells out more than the other is usually punished and the one that gets the shells of cash usually rises; although this is slightly different in the recent case of private equity deals, it stands good for this example where most oil and gas companies are publicly traded).

But before you do that, you have to check out whether your thesis is valid, or you could end up losing a pile of money. So first of all, you look at the chart for crude. You look at everyone else's opinion, and talk to all the experts you can find on the subject. Then you look at the oil companies themselves. What are they doing? Are they merging? What are their earnings like for the past year? For the past five years? What does the market think of oil companies right now (that will mostly be reflected in the P/E and P/B ratios, but also in the volumes of traded equities)? Are there any disparities in the valuations of smaller and the larger oil and gas companies? And how about oil exporters? Are they nationalizing oil? Are they reducing or increasing output? What effect does this have on smaller/larger oil and gas companies? Are they the same effects or different effects? What kind of liquidity do these companies have right now?

Now you're a financial journalist who sees the potential for a story on the same subject: wave of M&A activity sweeping the oil and gas industry. The above questions and processes are exactly the same for the research process of your story. You have a thesis, you have a pile of ( mostly disconnected) information and opinion, and you have to whittle it down into something comprehensible and as true as possible that either directly supports or directly challenges your thesis. It's called managing information, and it's what financial journalists and hedge fund managers alike do all day long.

Conflicts of Interest

When you're selling something, doing favors for people gets you a long way. This is not true when it comes to being right and first, and being right and first are the essential characteristics that define good money management and good financial journalism.

Chris Roush, in a post titled "Bartiromo's Plane Ride Raises Questions", seems to sum up pretty well the recent sentiment over CNBC "money honey" Maria Bartiromo's acceptance of trips of Citi's corporate jets at first-class-commuter prices. "Business journalism," he claims "is getting a bad rap after it was disclosed that CNBC anchor Maria Bartiromo took a plane ride on a Citigroup jet from China back to the United States." He goes on:

Bartiromo, according to a CNBC spokesman, took the flight for "source development" reasons, not for any specific story. But based on her long-standing friendship with the now-fired executive, it's clear that she could have had access to him anytime she wanted.

... What bothers me the most is that CNBC and Bartiromo -- who has also raised ethical questions by disclosing on the air that she owns Citi stock -- act is if nothing was wrong with the plane trip.

The problems should be obvious to them. Yes, business journalists are supposed to interview executives and push to talk to them as much as possible.

But the appearance of accepting something -- whether it's a plane trip halfway around the world or a lunch -- calls into question our integrity and motives with consumers of business news. And we're not supposed to be "friends" with the people we write about.

Somewhere along the line, Bartiromo and CNBC seem to have forgotten these basics.

The point that the general criticism, and Roush's post miss is that a financial journalist, just like a hedge fund manager, who is affected by their "friendship" with a Chief Executive to the point where that friendship influences their professional conduct will not be in a job for very long. If there was a major piece of negative news which came out of Citi, but a hedge fund manager who held a large portion of Citi stock chose to stick with his or her trade, knowing full well the stock may come down 5% plus, that hedge find manager would be called to question by lots of angry investors. If the same thing happened twice, the fund manager would find it hard to get a job again managing anyone's but his or her own - and maybe family's - capital.

The same point is true of Maria Bartiromo in the same situation: if her judgment as a result of her "friendships" with Citi execs were unduly affected in a crisis situation to the point where she was influenced enough to try and 'spin' the story, or worse, not to break the story at all, you can bet that it would most likely cost her her career. Even if she consistently tried to spin positive news for Citi, she, like any market participant, would get found out. It's the old law of "reversion to the mean". In other words, conflicts of interest are difficult not to reconcile in professions where being "right" is the key factor to your success.

Conflicts of interest are not the same in nature for financial journalists and money managers as they are, for, say, CEO's. In the latter situation, where a CEO tries to "front run" the market (make money on expected good or bad news buy buying or selling the stock ahead of time) on a pending news announcement, the action, if not prosecuted, would not necessarily affect the career of the CEO: it would merely make or save him/her a few million dollars. The CEO could potentially continue managing the company without repercussions.

It's perhaps a tough concept to grasp for those used to seeing every conflict of interest as inherently black, but in the case of Maria Bartiromo, the conflict of interest may in fact benefit the public, if only because she becomes more privy to the goings-on of Citi than your average punter, which is at the end of the day, what a financial journalist should be and must be in order to be effective. The same is true of a money manager - the more information they are legally privy to, generally the better for the investors in the fund.

The chastisement of Bartiromo is unfortunately motivated by the same emotion which motivates money managers to denounce the trading practices of successful peers: envy. It's with no uncertain peril we put successful and honest people out of their professions and amateurs in their place because of  overly-simplistic reasoning. Because in that instance, we all end up worse off, less-informed, and ultimately, more susceptible to the exact malpractice we were so afraid of in the first place.

UPDATE: Welcome (back) Instapundit readers! Thanks for dropping in. This is a blog principally about the economy, and you'll find that quite a lot of it is about global as well as U.S. markets. Please feel free to take a look around, comment, and of course, come back any time you like.

GOOGLE hits $500: MSFT hits 2-Year High: NASDAQ at 5-Year High

QUICK NEWS UPDATE (when is the media going to cover all this?):

Just as I predicted, Google stock has broken $500 for the first time today, valuing the search engine giant at over $155 billion:

This is what I said a couple of weeks ago:

Trading at 473.99 at the time of writing, having beaten Wall Street's expectation on Q3 earnings hansomely only a week ago, it's worth putting under the microscope. This is a company which made a 90% jump in Q3 earnings on the year to $733.4 million, and a revenue increase of 70% to $2.69 billion. While that sounds impressive, the company blew $1.65 billion of those dollars on Youtube, and unknown and untested brand only weeks ago. That's another six month's record earnings at the same level to make the acquisition profitable in absolute terms, without dividends, and without re-investment in its own business. And that's if the concept succeeds. NewsCorp bought MySpace on even more tenuous terms less than three months ago.

All this financing action looks very much like a replay of 1995/6, when Netscape and Yahoo! stacked up one-billion dollar plus IPO prices, except that's it happening in the form of trade sales rather than IPO's. That's predicatble enough. The tech bubble of the 1990's may not have endured, but the impression that the internet is a growth and medium catalyst for hundreds of industries didn't lose any lustre.

My guess is, despite Google's precarious revnue model, the stock spikes $500 before the year end, and a few more 'social networking' sites start charging precarious valuations based on their own one year busines models.

Microsoft has hit $30 for the first time in two years today too, making for a two year high:

This benchmarks are extremely significant as a guage of investor appetite for tech. The NASDAQ has hit another five-year high today too. It's only up from here.

New Product Launches

If there's one time you want to buy a stock, it's right before a major product launch. This has been the case for a long time: if you'd bought AOL a week before the launch of any of the Harry Potter movies, or Coca-Cola a week before the launch of Coke Zero, or even Mc Donald's a week before the launch of the chicken burger, you'd be up.

The latest candidate to fulfill this recurring product-launch prophecy has been Sony. The launch of the Playstation 3 has generated nothing short of hysteria, from people charging up to $650 on Craigslist for a place in the queue to get one of the new consoles, to a young democrat Senator's aid using the name of his employer to get some leverage on first-mover advantage on the product. As a result, the company's stock has picked up the best of it over the past couple days.

The following chart shows Sony benchmarked against the NASDAQ over the past six months:

It's pretty safe to call that underperformance. Now look at Sony benchmarked against the same index over the past five days:

In one of the NASDAQ's best weeks since the bull market of the late 90's, Sony stock has practically doubled the performance of the index. Video gaming fans would be best off buying the stock first, then using the gains to get the new Playstation.

11/15: Record Day For Markets

November 15, 2006 may well be remembered as the day U.S. markets turned, although the media are being somewhat sanguine about it. In short, yesterday was a record day for all markets - the Dow, the S&P, the NASDAQ, and for the big new tech stocks like Google.

The Dow broke another all-time high, trading up to 12,326.10 and closing at 12,251.71. That's the first time the Dow has broken the 12,300 mark intra-day and the first time it's closed above 12,250 in the history of the market (the following is a three month chart because it shows the closes better):

The NASDAQ had an equally historic day, reaching a new high since the tech bubble of 2,442.75 and breaking an intra-day of 2,450 for the first time since then:

The S&P however is the really exciting one, since this is the market critics of the recent bull run have been using to justify their bearish views. Only until the S&P starts breaking records, goes the argument, does this rally mean anything (initially it was the same argument used for the NASDAQ until that started breaking records). Yesterday, the S&P broke a six-year high, and was only 8% off an all-time high of 1,530.09 on intra-day trading:

As an addendum, search engine giant Google was 15 cents off reaching the landmark $500 a share that analysts have been speculating about since the summer (yesterday was another all-time for Google too, incidentally):

I expect we will see the stock break $500 before the week's end, just as I said a few weeks ago.

It's getting harder and harder to justify bearish views, and now the talk is all about a bubble, mainly by people who don't understand that a bubble requires the employment of excessive leverage (amongst other things), which there isn't right now.

I have pointed out here many times that a bull rally was only to be expected with lowering commodity prices and a sharp increase in private investment - despite lower GDP, which is feeding that spike in the private investment curve. The equity markets will continue to get the best of it - my predicition is that the NASDAQ tops 3,000 before year's end. And even then it's still cheap.

*UPDATE* Welcome back Instapundit readers! This is a blog about the economy, which is really to say it's about everything from politics to the arts to technology too, because that's really the jist of the economy. There's also a greater analytical scope on markets here than you'll find in most places. As always, please feel free to take a look around, comment and of course, come back.

**UPDATE** The same warm welcome is extended to Ace of Spades HQ readers, Memeorandum readers, and Townhall readers.

In The Bullring

US productivity is down, markets are down for the first time since June 2005 for five straight days (report). Then again, oil is down, sharply, and the Dow is hanging in there above that 12,000 threshold it reached last week and the Federal Reserve is still worried about inflation which means the economy must be growing. Most people are, understandably, walking around with question marks in their heads.

I pointed out a few days ago that productivity was unlikely to be up very much while private investment - which propells broader economic growth and hence inflation - was in the throws of massive expansion, because you don't get material produce - financial or industrial - until that private investment starts paying dividends in terms of earnings and produce. This is why GDP growth was down. Think of it from a personal point of view and it's easier to understand. If you start an online widget business and invest all the savings you have from last year's salary into that business, you don't get paid until either you a) earn something from selling some widgets online, or b) float your online widget company on the stock market and cash in some of your shares. That's productivity and GDP, and it's what's going on this year. It's also a very, very bullish sign for markets, which are all about earnings premiums, not current day scenarios.

To demonstrate this, I plotted some charts. This first one shows all the data from 1970 to present day of US private investment against US GDP growth (both nominal so no one like Daniel Gross over at Slate rehashes the cry me a river debate over nominal vs. real numbers):

There are several points of interest here. First of all, broadly speaking, look how the US has become a much more investment-heavy economy over the years. GDP growth having slowed is only natural, by the way, since it's the old law of 'it takes more to double 1 than to double 100'. The very fact that GDP growth even reaches levels of those thirty years ago says some bold things about the US economy. But most curiously, look how pre-1982 bull market and pre-1995 bull market GDP made a rapid decline as the private investment curve did the opposite and angled even steeper. This illustrates the point I'm making well; GDP declines rapidly if private investment goes up because there's not a lot being actually produced during that time. However, it comes back up a year to three years later, which is about the time all those private companies start paying out stock or dividends and selling some products. But most presciently of all, look how the curve on the private investment line has steepened up dramatically in the last few years. This, accompanied by short-term GDP growth decline, indicates a raging bull market is in the making. It's an EXACT replay of 1995 and 1981.

A scatterplot shows the correlations between the two sets of numbers:

There's a pretty solid negative correlation between GDP growth and private investment. What this means is that it's private investment which is negatively affecting GDP growth, just as discussed above. But what this scatterplot shows most revealingly of all is that this is particularly the case in bull markets, where the scatterplots are huddled together in a downward formation. The huddling effect we are seeing now - low GDP, steepening private investment curve - is the signal of good things to come in the market.

Not converted yet? Let's look at the Dow in terms of historical GDP growth and private investment:

The last two bull markets followed huge declines in GDP growth (the label should say GDP growth but it was late and I got lazy).

This is the Dow against private investment:

... and this one says it all. The Dow, which as I pointed out the other day with charts, leads the NASDAQ, is led by private investment growth: both of the last bull markets followed sharp increases in private investment. The action is actually a little more complicated than that, because private-stage investment and the markets are reflexive - mutually re-inforcing one another - after some time, but neverthless, the piggy bank start to swell first in private enterprise. What is truly alarming is how steep the PI curve has got, especially in correlation with GDP growth decline.

America needs to stop worrying about productivity, and start worrying about what to do with all the productivity when it comes about in the next three or so years, or it may find itself back in an enormous bubble. This is what happened in the late 1990's; productivity materialised, but was fed into productively non-existent assets, which killed the productivity cycle.

Either way, another bull market is coming.

Another AP Blunder: Oil

More terrible business reporting skills from the AP this morning:

Oil Inches Up in Wake of Last Week's Terror Alert in Gulf SINGAPORE (AP) -- Oil prices inched up Monday in the wake of a terror alert in the petroleum-rich Gulf region last week and as traders watched for signs that OPEC nations were following through on announced production cuts.

Light, sweet crude for December rose 7 cents to $60.82 a barrel in Asian electronic trading on the New York Mercantile Exchange.

Now, as you may recall, on Friday the AP's