2012: Fools and Strategists

By Derek On January 3, 2012 Under Post

“I’m sleeping less than I’d like.”
- Luis de Guindos, Minister of Economy and Competitiveness, Spain

German Sex Toys

Today is the first trading day of 2012 and I am back from a quick vacation with family to Germany for Christmas. Germany is a great place for a vacation, believe it or not. In an unstable world where social disintegration is at the door, “boring” is the new black. We had a great time in Flensburg, way up north in Schleswig-Holstein, and enjoyed the medieval city which coincidentally, has become the heart of the rising German sex toy industry. (Nothing to do with us).


Ancient Calendars

As they say, it is dangerous to make predictions, especially about the future, and I won’t make any here other than outline a few interesting trends we will be living with. 2012 in the Chinese calendar (beginning this year January 23rd) is the “Year of the Water Dragon.” “Water” in the Chinese universe is the most “Yin” of the five elements of wood, fire, earth, metal and water. The concept of “Yin” is one of darkness or even evil, while “yang” is good and bright, reflected in the philosophy of “YinYang.”

In the US we we say, “Yin and Yang” to differentiate from “Yingyang” which is an idiot; as in, “Don’t listen to that yingyang – he’s so stupid he thinks the English Channel is a TV station.”

So, from a literal fengshui point of view, 2012 is starting out here with some existential headwinds. What does recent history teach us? The last “Year of the Dragon” was the year 2000, when the S&P fell 10% and the world entered its post tech bubble recession. Not much joy there either. Looking ahead, December 21st 2012 is supposedly the date of the Apocalypse, according to modern misinterpretations of the ancient Mayan Calendar. The Mayans as a functioning civilization aren’t around to explain this one either but it certainly can’t be encouraging.

Three Big Threats

The three big threats we face – well trodden ground – are the European debt implosion, a stagnant US economy and a China slowdown. The likelihood of manipulated interest rates remaining near zero is close to 100%. As I write this, the US 10-year bond yield is 1.88% and I won’t be surprised to see it even lower come December. US house prices fell 3-4% last year and as a result Americans feel poorer. A house is most people’s largest asset and when you feel poorer you spend less. Don’t look to Americans with deep pockets and newly short arms to be much help to a wounded global economy.

We have some excitement to look forward to this month as S&P may downgrade top-rated Germany (and petulant sidekick France) before the next EU leader summit January 30th. Italy and Spain alone need to issue bonds worth 450 bn euro this year. Try paying that off with currently cruel 7% interest rates when you have 23% unemployment and a shrinking economy. Raising taxes and cutting spending isn’t going to help growth in Europe either. Just today, Spain’s economic minister, Luis de Guindos announced that his country’s budget deficit could exceed the forecast of 8% they made just last week! And that 8% forecast is higher than what was just promised to the EU…

Speaking to real Germans last week, there seems to be a real attachment to the euro from the man on the street. Most Germans realize the euro has benefited Germany enormously and they don’t want to let it go. However, nothing raises their collective Teutonic ire faster than stories of tax dodging Greeks retiring at 55 with full benefits while Mr. and Mrs. Schultz have to pay higher taxes to keep the game going. Reaching a political agreement here amongst the 17 nations in the euro area will take a long time and that is something markets won’t allow.


China Group Think

China is sitting on its own version of a debt bomb thanks to structural imbalances in their model of economic growth and the financial fire hose Beijing applied to the economy post GFC via the banks. All those dud loans which won’t be paid back are going to become harder to hide and another recapitalization of their banking sector is likely. In fact, Beijing has given the nod to a “one time debt extension” for repayment of interest and principal on SOE loans. In the west, we call this DEFAULT! China may have 3 trillion dollars in F/X reserves but a lot of that isn’t in cash under Hu Jintao’s bed, but rather in US Treasuries – and they aren’t getting it back. A severe slowdown for China this year, I think, would be a best case scenario (but I’m not making any predictions!). Certainly, the Shanghai composite index is forecasting at least that after falling 25% last year. On my recent trip through China visiting Kunming, Shanghai and Beijing, it was interesting to see how every single person and corporate is rock solid in their belief the RMB will continue to appreciate against the dollar, forever. It is a one way bet. Too bad there will be so many disappointed people. It reminds me of an earlier trip in 2009 when meeting with a senior executive at one of China’s largest listed insurance companies who told me happily, “You have to understand, China is different. IPOs in China are guaranteed to go up!” China is not different. Last year, 75% of China’s IPOs fell on the first day of trading. Oops.

Forecasting is for fools and strategists. Although sometimes I get them mixed up, I don’t envy either. 2012 looks and feels like it will make for interesting reading in the future but difficult times for us grinding our way through it. Lots to learn – not much to earn.

Good luck!

Derek Hillen, CAIA

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4 Comments Add yours

  1. chair rail
    January 16, 2012
    11:07 pm #comment-1

    Interesting…

  2. Mukul
    January 19, 2012
    7:42 pm #comment-3

    what are the risks your -ve views according to you? what will make you +ve?

    • Derek
      January 20, 2012
      10:18 am #comment-4

      Great question, thanks. The risks to my negative views are twofold: 1) Europe doesn’t melt down and can negotiate its way out this crisis. 2) A very strong rebound in the US economy provides just enough lift to the rest of the world that prevents another global recession. I think if China steps on the credit accelerator again (likely in the second half of the year) this just brings them to the brink sooner. I am long US assets and underweight Asia.
      Cheers.
      Derek

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