Thursday, 31 March 2005

US 4th quarter GDP maintains growth rate but weakness elsewhere

The latest figures from the Bureau of Economic Analysis show that US GDP grew at an annual rate of 3.8 percent in the fourth quarter of 2004, unchanged from its preliminary estimate.

James Picerno of The Capital Spectator points out that this is lower than the consensus estimate of 4.0 percent. Highlighting the role of the consumer in driving fourth quarter growth, he says:

Presumably, [the consumer] will be at the forefront of any first-quarter GDP advance as well. But it's an open question if the stock market sees the same future unfolding. The S&P 500 has slipped 2.5% so far this year. That's hardly a ringing endorsement of the notion that the economy has continued to hum along this year. True, earnings have been quite strong in recent quarters, but on a valuation basis the trailing price-earnings ratio remains stuck around 20, or roughly where it's been since last summer.

The view from the equity markets doesn't get any better if you break stocks into growth and value components. The Russell 1000 Growth Index (a proxy of large-cap growth stocks) is off more than 8% year to date. That's a steeper fall than the 5.6% loss YTD for the Russell 1000 Value Index, and more than two times the red ink logged by the broad market, measured by the S&P 500.

So what's an optimist to think? Perhaps he can start with some questions. How about this teaser: Shouldn't growth stocks be taking the lead over value stocks if the economy is advancing at a healthy clip? Or, are we to conclude from the recent meanderings of the major indices that Mr. Market has stumbled in connecting the macro-economic dots to equities.

Clearly, the stock market was encouraged today by the drop in oil prices and the confirmation that the fourth-quarter GDP exhibited decent growth. But additional declines in oil are needed to inject more life into stocks. Meanwhile, the consumer needs to keep spending. The two may be connected to a degree that some investors aren't yet willing to accept.

... "It's clear that concerns over prices -- especially gasoline -- are hitting consumer confidence hard," says Jerry Thomas, president and CEO of Decision Analyst...

A weaker American consumer would, of course, also hit Asian economies and their stock markets. As I have pointed out in recent posts, the news flow on the Asian front has not been good of late.

And things look little better in Europe. After the recent releases of the findings from the German IFO, Italian ISAE and INSEE surveys, Morgan Stanley economists Eric Chaney and Elga Bartsch wrote yesterday that "there are few doubts in our view: the European manufacturing sector is currently experiencing a sharp slowdown, which might turn into outright contraction in the second quarter".

Of course, such slowdowns often prove temporary. Picerno, for one, harbours the hope that oil prices may yet fall, pointing out that "[c]rude oil stocks continue to rise, and now reside in the upper half of the average range for this time of year". Chaney and Bartsch think that the slowdown in the European manufacturing sector is "a temporary correction". Japanese industrial output, despite falling in February, is expected to rise in March and April.

However, all these possibilities may be less relevant to stock investors than the fact that the world economy appears to be persistently flirting close to recession, dependent on the debt-laden American consumer and thus vulnerable to shocks on the downside.

With a market trailing price-earnings ratio -- as Picerno puts it -- "stuck around 20", have stock investors sufficiently taken this vulnerability into consideration?

Wednesday, 30 March 2005

Recession predictions and the outlook for Asia

Calculated Risk took a look at recession predictions and concluded that it is a mug's game.

Nevertheless, he joins in the game and, based on the yield curve and new home sales data, predicts: "I do not believe a recession is imminent. I'm just starting to watch for the early signs."

Barry Ritholtz at The Big Picture reviews the analysis done by Calculated Risk and concludes that it is consistent with his own "expectations for a contraction in 2006/07 time frame".

The Conference Board did report yesterday that its consumer confidence index fell to 102.4 in March from 104.4 in February. This by itself does not necessarily point to an imminent recession, but it does suggest that investors should at least start watching out closely for signs of an economic downturn.

This seems especially true for Asian investors. Yesterday, following up on a post at The Big Picture that said that the stock market may be approaching a top, I said that Asian stock markets are likely to be among the first to fall, citing weak economic data coming out of Japan, South Korea and Singapore.

The pattern continues today, with Japan reporting a 2.1 percent fall in industrial production in February. Offsetting this news, though, is the findings from a survey showing that manufacturers projected industrial output would rise 0.9 percent in March and 3.6 percent in April.

Meanwhile, the two Brads -- DeLong and Setser -- have interesting posts on China:

Peering into the Future of China

China has about a quarter of the population of the world

But would China revalue the renminbi to address other imbalances?

While DeLong looks at China holistically, the latter two Setser posts are about China's currency peg and its accumulation of foreign reserves. These are all relevant to discussions on a possible recession.

As William Pesek Jr at Bloomberg warns: "China's money supply is still growing apace... A nation with a pegged exchange rate is hard-pressed to run an independent monetary policy... [I]f the dollar crashed under the weight of record U.S. current-account and budget deficits, or China experienced a hard landing, the entire global economy would pay the price."

Tuesday, 29 March 2005

Stock markets looking toppish

Barry Ritholtz at The Big Picture thinks the coming rally should be used as an opportunity to exit most long positions.

Markets have reached the point where they are so oversold they are due for a corrective bounce. But I expect this bounce to be short. It should be used as an opportunity to exit most long positions, especially those that are cyclical, rate sensitive, or of the high Beta variety.

We suggest using the lift over the next 2 weeks to sell aggressively.

Several factors point to a rally...

Despite all these oversold signals, we remain concerned about the ongoing deterioration in Market internals and the Macro environment...

While I am not exactly bullish on the US stock market myself, I had suggested in a recent post that it might be more resilient than those in Asia and Europe. Recent economic news has reinforced my view that at least Asian markets are likely to be among the first to fall.

In Japan, the government reported today that salaried household spending in February fell 3.8 percent from a year earlier. In January, spending by such households had risen by 2.6 percent. Prospects for a sustained improvement in the months ahead look poor as Japan's unemployment rate also climbed to 4.7 percent in February from 4.5 percent in January.

In South Korea, the government reported today that industrial production in February fell 4.6 percent on a seasonally-adjusted basis after rising 3.1 percent in January. Production fell 7.3 percent from a year earlier. Corporate investment in plant and machinery fell 3.6 percent from a year earlier after rising 15.9 percent in January.

Yesterday, the Singapore government had reported that manufacturing output fell 9.8 percent in February on a seasonally-adjusted month-on-month basis. Output fell 10.2 percent compared to February last year.

One caveat for South Korea and Singapore, though, is that Lunar New Year effects may have accounted for at least part of the falls.

For my views on the outlook for the Singapore stock market, see "Singapore stock market flashes warning". My commentary yesterday entitled "Electronics stocks still underperforming" focuses on Singapore electronics stocks. As the titles suggest, I am not particularly upbeat on either the electronics sector or the overall Singapore market.

Saturday, 26 March 2005

Japan's core prices down in February

This does not look good for Japan, especially following other recent news.

Japan's core consumer prices down 0.4 percent in February
Core consumer prices in Japan sank 0.4 percent in February from a year earlier, the government said, indicating mild deflation was still haunting the world's second-largest economy. February marked the fifth straight month of a year-on-year decline, according to the Ministry of Internal Affairs and Communications... Month-on-month, core prices slipped 0.1 percent.

Core consumer prices in Tokyo, a leading index of nationwide trends, rose 0.4 percent in March from February but fell 0.5 percent from a year earlier.

Perhaps the Tokyo inflation rate points to a turnaround in the months ahead. Otherwise, one would have to ask whether Japan can achieve a sustainable recovery if it continues to be plagued by deflation.

Friday, 25 March 2005

Mixed economic news from US and Japan

There was mixed news on the US economy yesterday.

Durable goods orders for February were disappointing, edging up only 0.3 percent, according to a Commerce Department report yesterday. Strong aircraft orders helped keep the overall numbers positive. Excluding a 1.6 percent transportation orders gain, durable goods demand would have fallen 0.2 percent. Orders for non-defense capital goods excluding aircraft fell 2.1 percent, but the January advance was revised upwards to 4.4 percent.

However, the Commerce Department also reported yesterday that sales of new US homes soared 9.4 percent in February, the largest jump in more than four years.

Also, the Labor Department reported yesterday that the number of workers seeking first-time unemployment benefits climbed 3,000 in the week ended March 19 to 324,000. While the rise was unexpected, claims were still well below year-ago levels.

The news flow from Japan has been rather weak recently.

A joint survey by the Finance Ministry and the Cabinet Office found that business sentiment declined to 0.6 percentage points in January-March from 2.1 points in the three months to December. However, the business conditions index at large firms is expected to improve to 3.6 percentage points in the April-June period and to 9.8 percentage points in July-September quarter. The survey also found that firms were planning to cut their combined capital investment by 7.4 per cent in the year to March 2006.

On Wednesday, the Finance Ministry had reported that the trade surplus shrank 21.7 percent in February from a year earlier for the second straight month of decline. Exports rose 1.7 percent to 4.85 trillion yen, up for the 15th straight month, but in volume terms, exports were 4.2 percent down for the second straight monthly decrease. Imports increased 11.3 percent to 3.75 trillion yen, up for the 12th month. Higher oil prices helped inflate the value of imports.

Overall, a mixed bag of news that does not inspire confidence in the prospect for a re-acceleration of the world economy but does not quite point to an impending recession either.

Thursday, 24 March 2005

Stocks spooked by inflation fears

In its report released yesterday, the Labor Department said that the consumer price index rose 0.4 percent in February. Excluding food and energy, the index rose 0.3 percent.

The figures confirm the view that inflation appears to be picking up, following the previous day's report that the producer price index had also risen 0.4 percent and the Federal Reserve's remark that "pressures on inflation have picked up in recent months and pricing power is more evident".

Stocks reacted negatively to the notion of rising inflation.

In Asia, every major market fell except for Malaysia and Taiwan, which were little changed. Japan's Nikkei 225 Stock Average lost 0.9 percent to 11,739.12, its biggest decline in two months. Singapore's Straits Times Index fell 1.4 percent, South Korea's Kospi index slid 1.4 percent and Hong Kong's Hang Seng Index declined 1.3 percent.

In Europe, the Dow Jones Stoxx 50 Index dropped 0.3 percent to 2,854.44. Germany's DAX Index slipped 0.1 percent and France's CAC 40 Index lost 0.4 percent. The UK's FTSE 100 Index tumbled 0.5 percent. In addition, Germany's Ifo institute yesterday reported that business confidence in Europe's largest economy unexpectedly fell to 94 in March, the lowest since September 2003, from a revised 95.4 in February.

The US market was the only exception to the worldwide losses. The Standard & Poor's 500 Index added 0.82, or 0.1 percent, to 1,172.53. The Nasdaq Composite Index rose 0.88 to 1,990.22. The Dow Jones Industrial Average, though, slipped 14.49 or 0.1 percent to 10,456.02. However, the S&P 500 had fallen to a seven-week low in the previous session.

The Straits Times reported the fall in stocks with the headline "Asian markets overreact to Fed interest rate hike". It quoted UOB's head of treasury research, Jimmy Koh, as saying: "The Asian equity markets, which have been quite directionless for a few weeks, simply latched on to this piece of news and got carried away." He pointed out that the Fed did not mention "a runaway sort of inflation" and that the word "measured" was still in the Fed statement.

Koh may be sanguine, but rising interest rates have, more often than not, been followed by substantial falls in the stock markets. And yet, the level of interest rates counts.

The Capital Chronicle recently made the point that despite its recent narrowing, the spread between US 10-year Treasuries and 3-month T-bills "is not small enough" to suggest that a recession is imminent. And other indicators, like the Chicago Fed National Activity Index, tell "a similar story".

As for me, I always like to look at investor sentiment. I recently mentioned that Mark Hulbert has found sentiment among US investors to be relatively bearish. At the same time, however, fund managers tend to be more bullish on Asian and European stocks.

So if you believe in contrarianism, stay invested in the US but consider cutting back on Asia and Europe. I'm not sure how this suggestion sits with the ambivalent Capital Chronicle but I suspect Jimmy Koh may not agree.

Wednesday, 23 March 2005

Fed raises interest rates to 2.75 percent

Yesterday, the Federal Reserve raised its target for the federal funds rate by 25 basis points to 2.75 percent. In its statement, it said that while "longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident". Interest rate increases are "likely to be measured".

No doubt, the Federal Reserve would have been influenced by the latest producer price index, which was also released yesterday by the Labor Department. It showed that wholesale prices rose 0.4 percent in February, a slight increase from the 0.3 percent rise in January. Core PPI, which excludes food and energy, gained 0.1 percent, a sharp fall from January's 0.8 percent rise. Food prices rose 0.8 percent in February, while energy prices rose 1.4 percent.

Energy prices have continued to rise in March, although yesterday, oil prices did fall. NYMEX light sweet crude for May delivery fell US$1.43 to US$56.03 per barrel.

In other news yesterday, China's central bank governor Zhou Xiaochuan said the People's Bank of China may raise interest rates again in the second quarter of this year.

My quick take on all this is that if interest rates could rise in inflation-free Singapore, there is little chance of it failing to rise elsewhere.

Tuesday, 22 March 2005

S Korean economy disappoints, but China bullish

The latest report from the Bank of Korea shows that South Korea's economy grew 4.6 Percent in 2004. This is less than expected, pulled down by weak private spending.

South Korea appears to be just another one of the Asian economies that seem to be growing slower than expected. In contrast, the US economy continues to be strong, to the surprise of many economists. What accounts for the differing fortunes? Private consumption. Private consumption has proven to be surprisingly resilient in the US, while it has been disappointing in many Asian economies.

One Asian economy that may not need to rely on strong private consumption is China's. The country's Development Research Center of the State Council has issued a forecast that the Chinese economy will grow by up to 8 percent annually for the next five years.

"Calculated according to constant prices of the year 2000, China's Gross Domestic Product (GDP) would reach around 2.3 trillion dollars at the end of 2010. The per capita GDP would reach around 1,700 dollars," the report, cited by Xinhua news agency, said.

From 2010 to 2020, China's annual GDP growth rate would slow slightly to around 7.0 percent on average.

The major driver of growth in the period from 2006 to 2020 will be rapid capital formation, which will contribute between 60 to 70 percent of economic growth.

Monday, 21 March 2005

Sentiment falling with stock market

Roger Nusbaum has not been feeling optimistic about the stock market of late.

The Big Picture for the Week of March 20, 2005
I wrote something early in the week opining that I felt the likelihood of down a lot was now greater than it was before. I still hope I will be wrong but the continued deterioration of just about everything but oil has not made me feel any better

I will stick with my oft stated plan of waiting for a breach of the 200 DMA. I do not want to try to outguess what may come next, in case I'm wrong. It is important to have some discipline and I think I do.

The pessimism is understandable. US stocks were down last week, with the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite all falling. The Nasdaq in particular has fallen to a four-month low.

But Nusbaum isn't the only one to feel pessimistic. In a recent MarketWatch commentary, Mark Hulbert said that investor sentiment in general has been falling.

Each market correction seems to cause yet more previously-bullish advisers to throw in the towel. This typically is not what is seen at the beginning of major market declines... As of Thursday night's close, the [Hulbert Stock Newsletter Sentiment Index] HSNSI stood at 15.5 percent. As recently as March 9, when the Dow Jones Industrials Average closed at 10,806, the HSNSI stood at 38.1 percent. So the HSNSI has dropped nearly 23 percentage points in six trading sessions...

[T]he net effect of the stock market's gyrations this year has been to make the Dow Industrials in the low 10,600s look a lot more discouraging than it did before. And that's just another way of saying that a wall of worry is being built. And, as contrarians never tire of saying, bull markets like to climb a wall of worry... And so...there is a silver lining in the dark cloud of the market's recent decline.

Nusbaum may yet prove right in holding on.

Saturday, 19 March 2005

Consumer sentiment falls again in March

The University of Michigan index of consumer sentiment fell to 92.9 in March from 94.1 in February. It is the third straight month that the index has fallen.

In spite of this deterioration, Richard Berner at Morgan Stanley thinks that US consumption will remain resilient.

[A]s I see it, apart from the energy hurdle, key fundamentals are slowly turning more positive for the consumer. Hefty tax refunds are a short-term offset to the incipient energy "tax." Balance sheets for most households are gradually improving, and the typical consumer is less vulnerable to rising interest rates than is commonly thought. Most important, strengthening job and income growth likely is lifting spending wherewithal, especially for lower-income consumers. The result: Solid, if unspectacular growth is likely for now.

Betting against the US consumer has not been a good idea over the past few years. Will this time be different?

Friday, 18 March 2005

Bullish consensus?

A Merrill Lynch survey finds that fund managers opt for equities.

The latest monthly Merrill Lynch survey of fund managers shows a net 59 per cent of participants are overweight in equities -- the highest figure since Merrill began the survey in 1999.

There was a corresponding bearishness about bonds, with a net 57 per cent of managers being underweight in this asset class. For the first time since June, managers expect the global economy to strengthen over the next 12 months rather than weaken...

David Bowers, chief global investment strategist at Merrill Lynch, said: "... This is as consensus as it gets and begs the question of who the marginal buyer of equities is going to be in future."

Well, we have not seen the shoeshine boys and cab drivers make their appearances in the market in a big way yet.

But I suspect we probably won't -- not in this market cycle. Unlike during the Internet boom, this bull market does not have a "new economy" aura about it. Bubbles -- assuming they are bubbles -- are appearing in dull and old asset classes like housing and commodities, not in sexy stuff like dot.coms and high tech.

So yes, David Bowers may be right. This may be as consensus as it gets.

Thursday, 17 March 2005

US economy stronger than expected

The US current account deficit increased to $187.9 billion in the fourth quarter of 2004 from a revised $165.9 billion in the third quarter. The fourth quarter deficit is wider than most analysts were expecting. This may put further pressure on the US dollar, even though Asian central banks appear to be reluctant to let their own currencies rise.

Also higher but better was the news that US housing starts rose 0.5 percent in February to a seasonally-adjusted annual rate of 2.195 million units. Again, this is higher than what many were expecting.

US industrial production, though, rose a less-than-expected 0.3 percent in February. However, January's output gain was revised to 0.1 percent from an unchanged reading. And capacity utilisation in February rose to a higher-than-expected 79.4 percent.

What all these add up to is that the US economy is stronger than many had expected. This looks good at first glance. But it also means that underlying problems -- current account deficit, consumer debt -- are building up at a pace that could possibly be unsustainable, setting the economy up for a big fall later on.

When that fall might take place still remains a big question.

Wednesday, 16 March 2005

Economy remains resilient, inflation remains a concern

The latest Commerce Department report shows that US retail sales were up a lower-than-expected 0.5 percent in February. However, January sales were revised to show a rise of 0.3 percent instead of a fall of 0.3 percent as previously announced.

Meanwhile, China's industrial output rose 16.9 percent in the first two months of the year compared to last year, according to a National Bureau of Statistics announcement yesterday. Zhang Xueying, a senior economist with the State Information Centre, said: "This means the government's macro-control measures have little impact on the speed of the economic development, although the measures helped cool down the investment."

Sure enough, today, the National Bureau of Statistics reported that China's fixed asset investment grew 24.5 percent in the first two months of the year, far ahead of the government's forecast for 2005.

What the US retail sales and Chinese industrial output figures indicate to me is that the respective economies remain relatively resilient. It also suggests that fears of a pick-up in inflation cannot be dismissed yet.

Barry Ritholtz at The Big Picture, though, thinks that inflation is unlikely to run away.

Higher commodity prices tend to suck out discretionary spending that might go elsewhere, potentially bidding up prices. While that may be bad for retailers (especially discounters), it reduces the prospect for inflation increases . . .

The inflation outlook remains an important question mark. It will have a major impact on interest rates, which, of course, have a major impact on stocks. Rising interest rates, especially at this stage of the economic cycle, is often fatal to stocks.

Tuesday, 15 March 2005

Japan out of recession, China stocks in favour, Singapore interest rates on the rise

Japan managed to get out of recession in the fourth quarter of 2004, according to the latest data released yesterday.

Japan's GDP grew 0.1% in the three months to December
Japan's gross domestic product grew 0.1 percent in the three months to December from the previous quarter, according to revised data released Monday, up from an original estimate of a 0.1 percent contraction. On an annualised basis, the world's second-largest economy grew by 0.5 percent, compared to the initially reported drop of 0.5 percent in the first estimate released on February 16, the Cabinet Office said.

The revision showed positive growth after a contraction for two straight quarters, the widely accepted technical definition of a recession...

So there's still life in the economic expansion, but it will probably pay to be selective in investing from here on.

Speaking of which, Merrill Lynch has recently done some re-juggling of its market preferences. It has upgraded Chinese stocks but downgraded Thailand and Taiwan's.

Around Asia's markets: Thailand vs. China: Merrill lays a bet
Investors should buy Chinese stocks because earnings will probably exceed estimates, and they should sell Thai shares after a four-month rally pushed the benchmark index to a one-year high, according to Merrill Lynch.

Spencer White, the firm's chief Asian strategist, raised China's weighting in Merrill's country asset allocation model for Asia excluding Japan to 8 percent from 4 percent. He cut Thailand to 1.5 percent from 5 percent...
Merrill Lynch Downgrades Taiwan To "Market Weight"
Merrill Lynch & Co. has downgraded its rating on Taiwan to "market weight," citing expectations of "sustained retail selling" in the island's stock market through mid-May.

While the U.S. investment bank said both Taiwan's benchmark stock index and the technology sector will outperform in 2005, the local tax season typically spurs investors to sell off some of their holdings...

In Singapore, the climate may be turning even more sinister for stocks: interest rates are on the rise.

Housing mortgage rates in Singapore rising
Housing mortgage rates in Singapore are on the rise... UOB announced on Monday that it had raised its board rate by a quarter percentage point for new home loan customers. DBS will do the same, starting May 1. Over the weekend, Standard Chartered Bank said it would raise mortgage rates by half a percentage point for private homes. This is the second rate hike by Standard Chartered Bank this year. Just last month, OCBC announced that it would hike its board rate by 30 basis points to 5.8 percent from March 29...

Yesterday, I had recommended caution in investing in Singapore stocks in my commentary entitled "Singapore stock market flashes warning". The rise in interest rates may just be further evidence that the cycle has turned against Singapore stocks.

Monday, 14 March 2005

Temasek expands overseas

It looks like Singapore's state-owned investment firm Temasek is well on its way towards diversifying its assets outside the country.

Singapore's Temasek emerges as an Asian powerhouse after regional expansion
Singapore's Temasek Holdings is stamping its mark as an Asian powerhouse investor after a trailblazing multi-billion dollar shopping spree in the region over the past two years, analysts say. Temasek, which has interests in everything from banks to telecoms, airlines to energy firms, is now a major presence in the region, stretching from closest neighbour Malaysia to China and India.

Almost half of Temasek's portfolio, worth 90 billion Singapore dollars (55 billion US), is invested overseas with many of its foreign interests acquired over the past two years, company spokeswoman Rachel Lin told AFP. Lin said Temasek had invested more than three billion dollars globally since 2003 and it planned to continue increasing its foreign assets, not only in Asia but throughout the 30 Organisation for Economic Cooperation and Development (OECD) nations.

"Previously our portfolio was predominantly Singapore based," Lin said. "Currently, our portfolio is about 52 percent based in Singapore. In the next 8-10 years, we expect to see our portfolio transform to approximately one-third Singapore, one-third Asia and one-third OECD economies."

I am not sure about the investments that Temasek is making overseas, but in my opinion, now may not be the best time to invest in Singapore stocks anyway. See my latest commentary, "Singapore stock market flashes warning".

Saturday, 12 March 2005

US trade deficit, Chinese trade surplus grow

Yesterday's report by the Commerce Department that the US trade deficit hit US$58.3 billion in January, the second highest on record, will surely put further pressure on the US dollar.

The deficit was up 4.7 percent from a revised 55.7 billion dollars in December. Imports were up 1.9 percent to US$159.1 billion while exports rose 0.4 percent to US$100.8 billion. The politically-sensitive US trade deficit with China increased 7 percent to US$15.3 billion, but the deficit with the European Union fell 21.3 percent to US$8.1 billion while the deficit with Japan fell 9.3 percent to US$6.21 billion.

Earlier, the Ministry of Commerce in China had reported that the country's trade surplus in February was US$4.6 billion, up from US$6.48 billion in January. Exports were up 31 per cent to US$44.53 billion from a year ago, while imports slumped 5 per cent to US$39.92 billion.

Looking at the first two months of the year instead to offset the Lunar New Year effects -- the festival took place in February this year but in January last year -- the trade surplus was US$11.11 billion. Its trade balance had shown a deficit of US$8 billion in the same period last year. Exports rose 36.6 per cent year-on-year in the first two months of 2005 to reach US$95.28 billion while imports increased 8.3 per cent to US$84.18 billion.

While these statistics suggest that a revaluation of the renminbi is justified, inflation data is less conclusive. Yesterday, China's National Bureau of Statistics reported that China's consumer price index rose 3.9 percent in February over the same month last year. Again, the Lunar New Year may have had some effect, with prices of food, transportation and tourism most affected.

Prior to February, China had been seeing a deceleration in its inflation rate even as the US inflation rate has been threatening to accelerate. A slower inflation rate implies a stronger currency.

Friday, 11 March 2005

Oil may be a bubble, but not oil stocks

Like Andy Xie, apparently Larry Kudlow thinks that oil is a bubble too.

Really, when I put $55 a barrel on the table and look at it from as many different angles as I can, there is no way to justify the current price. As a free market disciple, I am of course compelled to accept the market’s verdict. It is what it is. Fifty-five dollars a barrel.

But that doesn’t mean it’s going to last. Nor can we rule out a speculative bubble such as occurred with Internet stocks five or six years ago. Bubbles do happen.

Clearly today’s episode is demand-driven, quite unlike the supply shocks of twenty-five years ago... All this said, it is instructive to note how much higher oil prices have jumped in comparison to other commodity increases... It suggests that the oil sector is way out of line. Increased China demand cannot alone explain it. But over-speculation can...

In the meantime, small investors thinking about jumping on the gravy train of higher oil prices should beware. Bubbles do happen. And the oil market could be on the verge of a major bubble-bursting.

In a commentary for BusinessWeek, however, Peter Coy says that oil stocks may still be a good investment, but only for patient investors.

So is Big Oil still worth owning? For long-term investors, probably yes... Michael Mayer of Prudential Equity Group... figures investors are braced for oil prices to drop gradually to below $30 a barrel by 2007...

Stock prices also look moderate in relation to expected earnings of oil companies. Thomson First Call says that the price-earnings ratio of the sector, based on analysts' predictions of 2005 profits, is 14, vs. 16.4 for the overall Standard & Poor's 500-stock index. The only sector with a lower forward p-e is finance.

In contrast, momentum players looking for a quick kill had better watch out. With stockpiles of crude and gasoline rising, there's a good chance that oil prices will fall at least a little... That's because supply is exceeding increased demand... The Energy Dept. says that as of Feb. 25, U.S. crude inventories were up 9% from the year before, while gasoline supplies, despite a worrisome drop in refinery usage, were up 10%, above their five-year averages.

Coy's analysis suggests that while oil itself is liable to correct in the short term, oil stocks may still be worth a buy for the long term, a conclusion that is not out of line with those in an earlier post of mine.

Thursday, 10 March 2005

Japan poised for growth

Despite Japan falling back into recession in 2004, things do look like picking up.

An index of leading economic indicators in Japan rose to 55 percent in January from a revised 41.7 percent in December, the Cabinet Office said yesterday. A number above 50 points to an expansion in three to six months. This is the first time in five months that the index is above 50.

Over in the US, the Conference Board's leading index for Japan was unchanged in January, the third consecutive month with no change. The Board comments that the "flatness of the leading index since the middle of 2004 suggests that the economy will grow in coming quarters, but probably at a very sluggish pace".

Andy Xie's price convergence theory revisited

Many economists are puzzled over why inflation remains so low globally. For example, in General Glut's latest post, he writes: "Strangely, annual PCE inflation is still just 2.2%, though, and even lower over the last six months (1.9% annualized) and three months (1.4% annualized)." Earlier, Brad Setser had written that "the fall in China's inflation rate [is] a bit of a puzzle".

And yet, there seems to be much resistance to Andy Xie's idea that low labour cost in places like China is forcing prices elsewhere to converge towards Chinese levels.

Incidentally, apart from explaining low inflation, Xie's postulate, which is essentially based on the concept of a huge excess labour supply in China forcing down wages, when combined with the offshore outsourcing phenomenon, also directly helps explain productivity improvements and low employment growth in developed economies. It also indirectly explains high commodity prices globally, low capital expenditure in developed economies and low interest rates.

When a theory uses one factor to explain so many observations, I tend to treat it with great respect. But at the moment, it remains only a plausible theory, albeit a highly plausible one. Economists should spend more time gathering hard evidence to prove or disprove Xie's theory. Otherwise, the debate threatens to degenerate into one where irrational fears clash with wishful thinking.

Wednesday, 9 March 2005

Oil around US$55 a barrel again

Andy Xie thinks oil is a bubble, but with NYMEX crude oil now at around US$55 a barrel, is it time to rush out and sell oil stocks?

Roger Nusbaum doesn't seem to think so.

Yesterday...I didn't think the stock market believed that $55 oil could stick based on a subdued reaction from oil stocks and that reducing exposure into the strength for short term people may make sense. If the about a bubble I would say no. I am aware of two bubbles since the SPX came to be in 1957. There was an energy bubble in the early 1980's and the tech bubble in 2000. In both instances those sectors grew to be about 30% of the index. Energy, today, has grown from 7% to 8.6% of the index. The stocks could correct but the run up has not been enough to cause an implosion.

And Barry Ritholtz is also not quite convinced.

Is energy becoming a crowded trade? When does the crowd turn into a mob? As in, when does this newfound appreciation of oil prices become a contrary signal? Jim Cramer mentioned yesterday he was a seller of oil stocks, but IMHO he's merely making a gut feel trade (also known as a guess). I need a more concrete sell signal before blowing out.

Seem reasonable to me. Oil itself may be a bubble, but the valuation for oil stocks don't seem particularly out of line with the rest of the market.

Tuesday, 8 March 2005

Brad Setser interprets Andy Xie

Brad Setser has a post discussing the comments made by Andy Xie that Chinese prices won't converge to US levels so much as US prices are likely to fall to Chinese levels, which I had also linked to in an earlier post.

Brad Setser does not quite agree with Xie that China will get to set US price levels because he thinks that the Federal Reserve has the tools -- that is, the printing press -- to generate inflation. Others who added comments point out that China's labour supply is not quite infinite, that productivity gains must have some impact on China's wage levels, and that the US can always resort to protectionism.

All these objections are true, of course. But they take Xie too literally in the first place.

A realistic takeaway from Xie's article is not that US prices will actually fall to where Chinese prices are now. Rather, it is that China will have a bigger influence than other emerging economies have had in previous decades, and that the deflationary forces that it is unleashing globally must be treated with greater respect than seems to be the case at the moment.

Xie is an iconoclast. He likes to paint his scenarios in stark and extreme terms. Such descriptions are seldom realistic. But they are often helpful in shaking up existing mindsets. And they do make interesting reading.

If you don't have enough of Xie, you can read his latest commentaries entitled " The Liquidity Conundrum" and "The NPC - Marginal Changes".

Monday, 7 March 2005

Stock indices showing divergence

Last Friday, the Dow Jones Industrial Average hit 10,940.55, its highest close since June 2001, while the Standard & Poor's 500 index hit 1,222.12, its highest since July 2001. The Nasdaq composite, in contrast, closed at 2,070.61, almost 5 percent below its high in December 2004.

This divergence is troubling to me, because divergences often precede market reversals. Is the current divergence indicating a potential reversal of the US stock market? I discuss this in today's commentary entitled "US stock market bullish but divergence and valuation are concerns".

Incidentally, this divergence isn't restricted to the US market. If anything, it is even more pronounced in Singapore, where the main Straits Times Index is near its highest level since 2000 while the smaller Sesdaq is 32 percent below its peak hit in October 2003.

The divergence between the STI and Sesdaq may not have any direct relevance to the US market, but it may have much relevance to the Singapore market itself. More on this later.

Saturday, 5 March 2005

US economy doing fine but beware impact of China and outsourcing

The US economy continues to do fine.

Factory orders rose 0.2 percent in January on electrical equipment strength, according to the Commerce Department. Excluding transportation, factory orders rose 1.1 percent in January. December's factory orders were revised to a 0.5 percent rise from an originally reported 0.3 percent gain. January orders for durable goods, however were revised to a 1.3 percent fall from a 0.9 percent decline.

Meanwhile, the Labor Department reported that the US economy created 262,000 jobs in February, almost twice the January gain, which was revised to an increase of 132,000 jobs. As CNN noted: "It was only the second time job growth has reached the quarter-million mark in the last nine months, and the second time during that period that payroll growth did not trail economists' forecasts."

Consumer sentiment, though, fell in February. The University of Michigan's final reading of its consumer confidence index for the month was 94.1, down from January's final reading of 95.5.

Barry Ritholtz at The Big Picture has been betting each month that the jobs report would show a lower figure than consensus. Although that proved wrong this time, as the CNN report noted, it is generally the way to bet.

Strangely, though, in trying to determine why economists tend to get the figure wrong, he dismisses outsourcing as a reason, saying that it has "been pretty thoroughly reviewed by economists". Since my own view has been that US-based economists -- the ones who count since they are the ones who forecast US jobs -- have tended to underestimate the impact of offshore outsourcing, I would have to disagree with him.

For some of my recent commentaries that touch on outsourcing-related issues, see "The impact of China on the world economy" and "US demand and Chinese production".

Andy Xie of Morgan Stanley recently also touched on another area where China's impact may not be properly understood.

Investors compare China with various economies at similar stages of development and draw the conclusion that commodity and/or asset prices will go much higher. Property speculators compare Shanghai with London and view the gap in property prices between the two as the potential upside. Currency traders look at the productivity growth in China and believe that the renminbi will appreciate as the yen did 30 years ago. The global financial community is making the mistake of assuming that Chinese prices will rise to international levels as the economy develops. Instead, international prices are more likely to decline to Chinese levels through arbitrage by global companies, in my view.

The views here are not new. Xie has been talking about this for some time, and I had touched on it in my commentary "Fight against global deflation must involve Asia". Whether many people are listening is another story.

Friday, 4 March 2005

Chip industry sluggish, but Samsung optimistic

The semiconductor industry looks like it will be facing prolonged sluggishness, according to the latest forecast from Gartner. The research forecasts semiconductor revenue in 2005 to grow by 3.4 percent, way down from 2004's 23.9 percent.

It expects sequential quarterly growth to be negative in the first quarter of 2005 and flat at best in the second quarter. Seasonal slowdowns in electronic equipment sales are expected to exacerbate the effect of inflated inventory levels.

Gartner analysts said growth will remain muted in the first half of 2006 but begin to improve in the second half.

Meanwhile, Merrill Lynch has downgraded its "buy" ratings on South Korea's Hynix, the world's second-largest memory maker, and Taiwan's Powerchip Semiconductor Corp. to "neutral", saying weak demand for chips had triggered a faster-than-expected fall in memory chip prices. It has also cut its earnings forecasts for Micron Technology Inc. of the US and Germany's Infineon Technologies.

And as if to underline Merrill Lynch's point, yesterday Hynix reported disappointing fourth quarter results.

The world's second-largest chip maker, Samsung Electronics, however, continues to exude a bullish aura. On Wednesday, Hwang Chang-gyu, president and chief executive of Samsung Electronics' semiconductor operations, said that this year's revenue will rise 25 percent from last year's sales of $16 billion, as global chip demand will be underpinned by the growing use of microchips in mobile applications such as digital cameras, MP3 players and other electronic devices.

Thursday, 3 March 2005

Bubble in art

Barry Ritholtz at The Big Picture highlights the frenzied bidding for art works as another indication that there is too much money around, and "it is a foreboding sign" for equity markets.

She Can't Be Bought
In January, one of the art world's brightest young stars, Julie Mehretu, was put on display in a highly unusual way -- on the stand in a Manhattan courtroom, where she’d been called to testify by her dealer, who's feuding with a collector over her work... The suit was brought by Jean-Pierre Lehmann, a leading collector of cutting-edge contemporary art who was there to assert his right to buy Mehretu's paintings...

"This case shows the length a collector would go to secure themselves choice material," says Sandy Heller, an art consultant to some of New York's top hedge-fund managers...

When did collecting art become such a maddening exercise for wealthy collectors, akin to having to go before picky co-op boards only to be rejected over and over again? Even Rembrandt and Dürer had waiting lists. But "lists for younger artists are a much more recent phenomenon," says Chelsea dealer Barbara Gladstone. "It's a function of this excitable market." People on Wall Street are seeking contemporary-art trophies -- and waiting lists make works even more enticing to obtain. It sounds familiar, and naturally everyone wonders when this bubble will burst. Right now "feels like the last days of the Roman Empire," says private-art curator Todd Levin. "Compared to the eighties, it’s a much broader group with much more money" -- though some of the people are the same ones who bought art the last time around.

I discuss this and other bubbles in "Bubbles everywhere -- and about to burst?".

Wednesday, 2 March 2005

Hope for Japanese consumption

After the strong 2.1 percent jump in industrial output in January, Japan yesterday reported that January unemployment was at 4.5 percent while household spending was up 2.6 percent for the first rise in three months and compared with expectations for a fall of 1.2 percent.

The January unemployment rate was the lowest level since January 1999. The number of unemployed people was 2.96 million in January, down 270,000 from a year ago, marking the 20th straight monthly decline.

The government had also reported on Monday that retail sales in January rose at the fastest pace in more than six years and that housing starts increased at twice the expected rate.

"Given the easing in the pressures (on employment from corporate) restructuring and improving labour and wage conditions, which were confirmed by today's announcements, private consumption is unlikely to see a serious decline ahead," Osamu Katano, an economist at Mizuho Securities, was quoted as saying.

In December, Andy Xie had said on CNBC that Japanese consumer spending is "an eternal dream". Well, that dream may yet come true.

Tuesday, 1 March 2005

US homes sales fall, spending flat, while Asian output generally up

There was plenty of economic news yesterday.

In the US, the Commerce Department reported that sales of new homes fell 9.2 percent in January while the median price of a new home fell 13.2 percent to the lowest level since December 2003. According to Associated Press, analysts blamed "the worse-than-expected showing on bad weather in many parts of the country rather than any serious problems in the red hot housing market".

In another Commerce Department report, personal incomes, which had been bolstered by a large stock dividend payment by Microsoft in December, fell 2.3 percent in January. This was after rising 3.7 percent in December. However, without the dividend payment, personal incomes would have shown stable gains of 0.6 percent in December and 0.5 percent in January.

In the same report, personal consumption expenditure was unchanged in January after having risen by 0.8 percent in December. The price index for personal consumption expenditure excluding food and energy, a gauge of inflation, rose 0.3 percent in January, the biggest one-month jump in more than three years.

Meanwhile, business activity in the Chicago area expanded slightly in February. The latest Chicago purchasing managers index reads 62.7 percent compared with 62.4 percent in January.

Earlier yesterday, Japan had reported that its industrial output jumped 2.1 percent in January, beating economists' forecasts and raising hopes of an economic pickup there, while in South Korea, annual industrial production growth accelerated to 14.2 per cent in January from 4.6 per cent in December.

Less optimistically, Singapore's manufacturing output for January fell 7.6 percent on a seasonally-adjusted month-on-month basis. Output was mainly hurt by a fall in the volatile biomedical manufacturing cluster, which contracted by 8.6 percent over January last year.