Fwd: Roger Kubarych, "Ten Myths Markets Must Overcome in 2014"
Josh Whitcraft
From: Craig Drill <cdr...@cdccorp.com>
Date: Mon, Dec 23, 2013 at 1:52 PM
Subject: Roger Kubarych, "Ten Myths Markets Must Overcome in 2014"
To: cdr...@cdccorp.com
CRAIG DRILL CAPITAL
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TEN MYTHS MARKETS MUST OVERCOME IN 2014
Roger M. Kubarych
December 23, 2013
1. US stocks are bought only because the US is the best market in a bad neighborhood
Reality: If that “bad neighborhood” is supposed to be the debt-troubled eurozone and Japan, the fact is that the Greek stock market, up more than 35% in US dollar terms, has been the best performer in the past year. Moreover, Japanese equities have matched US indexes and outperformed most European ones. Greece has benefited from credible decisions by the European Central Bank to “do what it takes” to deal with the country’s financial needs, while the new Japanese government has backed aggressive monetary policies to stimulate business activity and in the process, lift inflation. Stock markets applauded.
2. Tapering the Federal Reserve’s quantitative easing program means tightening
Reality: Notwithstanding lurid headlines like the one in the Financial Times: Fed’s taper decision signals end of era for easy money, the Fed has done a pretty good job convincing many market participants that this is just a myth. And the central bank backed it up with a pledge that the all-important Fed funds rate target will be left at near-zero levels even when the US unemployment rate slips below 6.5%. The result was a lusty rally in the US and other stock markets for the solid reason that the overall Fed move indicates confidence that US growth is on stronger footings, while inflation dangers are minimal. That is ample justification for buying stocks. To be sure, players in emerging market fixed-income and foreign exchange reacted as if the myth was valid, but that will change with experience.
3. The US government is dysfunctional
Reality: The budget deficit has dropped from 10% of GDP to about 4%. Yes, sequestration was a blunt instrument that left defense planners and domestic program managers with inadequate flexibility to move funds from lesser to more important priorities. But the budget compromise struck over the past weeks by Congress will rectify much of this flaw, without interfering with the main thrust of fiscal policy: progressive, livable austerity. Sure, it doesn’t come easily, but it functions. And the bond markets are comfortable with the results.
4. The US dollar is a weak currency
Reality: Yes, a weaker dollar…but only against the reviving euro and a handful of other currencies. But the dollar is hardly weak against the Japanese yen, which has plunged 20% in the past year as a result of dramatic change in Japanese monetary policymaking. And dollar exchange rates have moved decidedly higher against almost all commodity-producing countries, notably Canada, Australia, and Brazil.
5. China is harmless because it is all about making money
Reality: The main thrust of Deng Xiaoping’s tenure was a non-ideological quest to modernize China’s economy by attracting foreign capital and technology to build a world-class export sector and amass financial resources. His main support came from the military, convinced that they could not be taken seriously in a country with an unproductive economy. The strategy worked beyond all expectations, Deng’s and analysts’ everywhere. Now China has $3.5 trillion in reserves, a chronic trade surplus, and ambitions to invest all over the world, especially to acquire natural resources. It is also investing heavily in its military, not the least of which is a modern navy. The days of simply focusing on economics and finance are over, as evidenced by bullying tactics in the East China and South China Seas that can easily lead to conflict with Japan, South Korea, and the Philippines. The US and its allies are hardly unified in how to respond, if at all.
6. Energy companies are fat and happy
Reality: Actually, they are fat and unhappy. Admittedly, Brent oil, the world benchmark for crude, is still costly at almost $110 a barrel, with US domestic oil prices running about 15% lower. Meanwhile, US natural gas prices have doubled from the lows of a year or so ago. So oil and gas companies remain highly profitable, but investors are not impressed. This reaction is due, at least in part, to the companies not returning much of their cash hoard to shareholders, and partly to the fact that returns from many new fixed investments are slumping because the major oil companies were late getting involved in the fastest growing sectors of shale gas and tight oil. And the next major focus, development of the sub-salt plays off-shore Brazil, is not open to foreign investment after a U-turn by that country’s politicians toward narrow nationalism. Sophisticated investors do not readily embrace the myth of ever increasing profits in the sector.
7. Emerging market stocks are unattractive
Reality: The rush out of emerging equity markets is largely over, as investors are becoming more sanguine. The notion that those markets have little upside is far-fetched, mostly because of the sharp declines in valuations that have already occurred. The culprit: softer commodity prices, outside the oil sector. So, in US dollar terms, some emerging markets are down: Colombia’s market is off just under 20%, Chile’s is 20% lower, and Brazil’s has dropped almost 30%. Even the Indonesian market, which had come close to the “overbought” range a year ago, has come back down to earth having fallen 20% this year. Opportunities abound.
8. The Putin push to reestablish a Russian empire endangers global peace and stability
Reality: The ham-fisted attempt to bring Ukraine into the Russian orbit seems to be working, even as the Ukrainian population continues to reject their president’s capitulation (admittedly accompanied by relatively attractive financial terms). But what does Russia get for its efforts and generosity? A country with per capita income of $7,500 a year, ranked 112th by the World Bank, with few world-class industries outside agriculture, enormous debt, and disillusioned young people longing to move somewhere else. Ukraine could turn out to be Russia’s Vietnam, a drain on its budget and an embarrassment internationally. Thus, internal constraints will set widening limits on how much scope Russia has for playing a disruptive role globally.
9. Arab Spring was a breath of fresh air as democracy spreads across the region
Reality: This romantic myth was never based on fact, which is that none of the uprisings and their immediate consequences had any chance of implanting Western values, economic progress, or internal stability. Instead, what has happened is a reemergence of the entrenched interests of the military and its confederates or, alternatively, Islamist fundamentalists who spurn the modern world. Fortunately, the region is not typified by the extreme case of Syria, which has a civil war that is a human and economic nightmare. Nevertheless, neither Egypt nor Libya is on a path toward Jeffersonian democracy, but that does not mean that either country is hopeless for investors. Bold acquisitions of Egyptian equities a year ago would have earned almost 10% in dollar terms, much of which, of course, reflects a hefty risk premium.
10. Deflation is a greater danger than inflation
Reality: How many of the fifty most important economies are registering declines in their price indexes for 2013? The answer is two: Greece with a deflation rate of -0.8%, and Switzerland with a deflation rate of 0.1%. Even debt-troubled Spain, with a pressing need to become more competitive at a time when its currency, the euro, is appreciating, will post a year-over-year increase in consumer prices of 1.5%. To be sure, there is deflation of global commodity prices, apart from oil and gas, on the order of 10% or so. That reflects lessened demand at the margin from China and a few other large emerging markets that are significant importers of food, non-food agricultural and industrial commodities. But these countries are still growing. It is a better bet that with a solid expansion in the private sector in the US, an improving business climate in Europe and Japan, and a general pick-up of emerging market activity, commodity prices will inch up in 2014. Deflation will soon recede from the list of downside risks.
Merry Christmas and a Happy New Year!
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