On the Road to Japan, YTD Equity Performance, Why China Real Estate, Oil and the Diet Debacle!

From: Aditya Rana
Date: Sat, Jul 14, 2012 at 1:44 PM
Subject: On the Road to Japan, YTD Equity Performance, Why China Real Estate, Oil and the Diet Debacle!


The continued weak performance of the US and European economies, under a backdrop of deleveraging and insufficient demand, invokes comparisons to Japan as a guide to what might be expected over the course of this decade in the western developed world. Gerard Minack from Morgan Stanley has written an interesting note which highlights the similarities, and some differences, in the growth path of the three economies which provides an useful tool to analyse potential future scenarios for the US and European economies. To summarise:

-The first clear similarity is that the three economies have suffered from a bursting of a credit bubble and are now dealing with the aftermath – an extended period of deleveraging. This process is made more difficult with a declining trend in nominal GDP growth (as the attached chart illustrates by making comparisons between the US and Europe and Japan at the same stages of Japan’s cycle-a theme repeated in the comparisons below).

-The second-similarity is that fiscal stimulus works – Japan used fiscal stimulus repeatedly during the 1990s, having a subsequent positive impact on private spending (see chart below) . The sharper initial recovery in the US and Europe was due to a more aggressive initial fiscal stimulus in response to a larger initial downturn.

-It is the change in the cyclically-adjusted budget balance which provides the fiscal stimulus – and in this regard the US stimulus has been the most aggressive with the budget balance falling by 6% of GDP within a two year period, compared with about 3% for Japan and Europe (see chart below).

– However, US and Europe started with a weaker initial budget balance (a deficit versus a surplus in Japan) and a higher public debt than Japan and therefore now have less room. US and Europe are under pressure to tighten fiscal policy (Europe has already started ) and this could turn out to be the key differentiating factor from Japan (see chart below).

-Monetary policy has been much more aggressive in the US and Europe versus Japan, but deleveraging has blunted its effectiveness. Long-term bond yields are following a similar declining pattern as in Japan, and it has been dangerous to call a trough in yields . It is debatable whether this is due to central bank action or investor fears about a Japan like scenario unfolding, but the impact on equity prices has been somewhat limited.

-Unconventional monetary policy by the way of Quantitative Easing, was also followed more aggressively by the US and Europe than Japan (see chart below) . While these actions were effective in dealing with the initial liquidity stresses, they were less effective in stimulating economic growth and the US actually suffered steeper declines in money velocity (the speed with which money circulates in the economy) than Japan.

-Inflation has also increased more in the US and Europe than Japan as they experienced more rapid economic recoveries, after declining more rapidly during the initial phase as their economies contracted more (see chart below).

-Another reason behind the sharper rise in inflation in the US and Europe was the V-shaped recovery in emerging markets which lead to higher commodity prices. As global growth now falters, inflation could follow the downward trajectory in Japan.

-The current slow-down is more worrisome than in 2010 and 2011, as OECD leading indicators have fallen more rapidly (see chart below), with the scope for more aggressive policy action being limited due to zero-bound interest rates and the fiscal contraints mentioned earlier.

-Meanwhile, equity markets in the US have mirrored the swings in the economic cycle which bear a striking similarlity to the swings in Japanese equity markets.

Interesting insights provided by making the comparisons for key economic and financial indicators over the phase of Japan’s cycle. Below trend growth in the 1.5% area for the developed world over the course of thsisdecade seems very likely, particularly given that policy makers in Europe and the US are reaching limits to further stimulative actions. This is particularly true of fiscal policy, which is more subject to the political divide in the US and the north-south divide in Europe. As I have noted in previous newsletters, this implies that centrla banks will have to do much more of the heavy-lifting via more aggressive quantitative easing policies. While the impact of QE policies on markets and economic growth maybe diminishing (see chart below) , its is (at this stage) the only game in town (and it works) and we can expect more novel methods of QE down the road (purchase, directly or indirectly through banks, of more risky assets). We are likely to get the first glimpse of such action in the next month or so as the global slow-down, and a resurgence of European worries, forces the hands of centrla banks. The implications for investors is to patiently wait for market corrections to add to exposure, and ligthen-up when markets get heady. This strategy is more relevant for developed markets, while emerging markets remain on a secular uptrend – though with cyclical downswings along the way.

I thought it would be uuseful to take stock of the peformances of major equity markets, and its interesting to note that the Indian stock market is the best performing market this year in local currency terms (up 13.4%-see chart below) after being one of the worst performers last year. The return in US$ terms is also a very respectable 10.2% which would make it second only to the Nasdaq! (the penultimate page of The Economist has a table which provides YTD returns in local currencies and US$ for all stock markets). China has underperformed, but I expect this to reverse during the second-half of this year as China begins to stimulate more aggressively. The Chinese real estate sector is likely to benefit signifcantly from the stimulus and valuations (see second chart below) are at historically attractive levels. Please note that, as the Mckinsey survey on urbanization noted last week, China is expected to account for about a third of the global increase in building space over the course of the next 15 years, totalling $25 trillion!

Lastly, a comment on Oil. There have been a lot of media attention on the impact of Shale oil on the oil markets, and while this has important ramifications – with the US potentially acheiving oil sel-sufficiency by 2030, it still leaves the world with a oil supply gap of 20 million b/d by 2030 to be bridged by yet-to-be discovred resources (see chart below from a Blackrock/Wood Mackenzie report). Recent research by the IMF predicts that growth in demand will put continual upward pressure on price, with the inflation-adjusted price of oil headed for $180/barrel by the end of the decade (see second chart below). According to their estimates, those price increases would be sufficient to keep global production increasing at about the same reduced rate we have seen since 2004.

The Diet Debacle:

As a second part of my series on the importance of diet in maintaining good health, I present a fascinating article (via Project Syndicate) by Robert Lustig , Professor of Clinical Pediatrics in the Division of Endocrinology at the University of California, San Francisco. It highlights the growing global epidemic in chronic metabolic disease (which includes diabetes, heart disease, cancer and dementia) which arises due to modern diets combining fat, carbohydrates, glucose and fructose, which are all metabolized differently by the body and therefore put excess strain on the liver leading to a “fatty liver” which in turn causes chronic metabolic disease. It is estimated that 40% of normal-weight people around the world have chronic metabolic disease, which is a bigger threat to health now then infectious disease!

It is interesting to note that one of the basic tenets of Ayurveda is eating the right food combinations, and, for example, combining fruits with meals is strictly forbidden as they are digested differently! So a case of modern science proving age-old knowledge?!

May. 28, 2012Thank you. You’re human.

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SAN FRANCISCO – Two seemingly benign nutritional maxims are at the root of all dietary evil: A calorie is a calorie, and You are what you eat.Both ideas are now so entrenched in public consciousness that they have become virtually unassailable. As a result, the food industry, aided and abetted by ostensibly well-meaning scientists and politicians, has afflicted humankind with the plague of chronic metabolic disease, which threatens to bankrupt health care worldwide.

The United States currently spends $147 billion on obesity-related health care annually. Previously, one could have argued that these were affluent countries’ diseases, but the United Nations announced last year that chronic metabolic disease (including diabetes, heart disease, cancer, and dementia) is a bigger threat to the developing world than is infectious disease, including HIV.

These two nutritional maxims give credence to the food industry’s self-serving corollaries: If a calorie is a calorie, then any food can be part of a balanced diet; and, if we are what we eat, then everyone chooses what they eat. Again, both are misleading.

If one’s weight really is a matter of personal responsibility, how can we explain toddler obesity? Indeed, the US has an obesity epidemic in six-month-olds. They don’t diet or exercise. Conversely, up to 40% of normal-weight people have chronic metabolic disease. Something else is going on.

Consider the following diets: Atkins (all fat and no carbohydrates); traditional Japanese (all carbohydrates and little fat); and Ornish (even less fat and carbohydrates with lots of fiber). All three help to maintain, and in some cases even improve, metabolic health, because the liver has to deal with only one energy source at a time.

That is how human bodies are designed to metabolize food. Our hunter ancestors ate fat, which was transported to the liver and broken down by the lipolytic pathway to deliver fatty acids to the mitochondria (the subcellular structures that burn food to create energy). On the occasion of a big kill, any excess dietary fatty acids were packaged into low-density lipoproteins and transported out of the liver to be stored in peripheral fat tissue. As a result, our forebears’ livers stayed healthy.

Meanwhile, our gatherer ancestors ate carbohydrates (polymers of glucose), which was also transported to the liver, via the glycolytic pathway, and broken down for energy. Any excess glucose stimulated the pancreas to release insulin, which transported glucose into peripheral fat tissue, and which also caused the liver to store glucose as glycogen (liver starch). So their livers also stayed healthy. And nature did its part by supplying all naturally occurring foodstuffs with either fat or carbohydrate as the energy source, not both. Even fatty fruits – coconut, olives, avocados – are low in carbohydrate.

Our metabolisms started to malfunction when humans began consuming fat and carbohydrates at the same meal. The liver mitochondria could not keep up with the energy onslaught, and had no choice but to employ a little-used escape valve called “de novo lipogenesis” (new fat-making) to turn excess energy substrate into liver fat.

Liver fat mucks up the workings of the liver. It is the root cause of the phenomenon known as “insulin resistance” and the primary process that drives chronic metabolic disease. In other words, neither fat nor carbohydrates are problematic – until they are combined. The food industry does precisely that, mixing more of both into the Western diet for palatability and shelf life, thereby intensifying insulin resistance and chronic metabolic disease.

But there is one exception to this formulation: sugar. Sucrose and high-fructose corn syrup are comprised of one molecule of glucose (not especially sweet) and one molecule of fructose (very sweet). While glucose is metabolized by the glycolytic pathway, fructose is metabolized by the lipolytic pathway, and is not insulin-regulated. Thus, when sugar is ingested in excess, the liver mitochondria are so overwhelmed that they have no choice but to build liver fat. Today, 33% of Americans have a fatty liver, which causes chronic metabolic disease.

Prior to 1900, Americans consumed less than 30 grams of sugar per day, or about 6% of total calories. In 1977, it was 75 grams/day, and in 1994, up to 110 grams/day. Currently, adolescents average 150 grams/day (roughly 30% of total calories) – a five-fold increase in one century, and a two-fold increase in a generation. In the past 50 years, consumption of sugar has also doubled worldwide. Worse yet, other than the ephemeral pleasure that it provides, there is not a single biochemical process that requires dietary fructose; it is a vestigial nutrient, left over from the evolutionary differentiation between plants and animals.

It is therefore clear that a calorie is not a calorie. Fats, carbohydrates, fructose, and glucose are all metabolized differently in the body. Furthermore, you are what you do with what you eat. Combining fat and carbohydrate places high demands on the metabolic process. And adding sugar is particularly egregious.

Indeed, while food companies would have you believe that sugar can be part of a balanced diet, the bottom line is that they have created an unbalanced one. Of the 600,000 food items available in the US, 80% are laced with added sugar. People cannot be held responsible for what they put in their mouths when their choices have been co-opted.

And this brings us back to those obese toddlers. The fructose content of a soft drink is 5.3%. Of course, many parents might refuse to give soft drinks to their children, but the fructose content of soy formula is 5.1%, and 6% for juice.

We have a long way to go to debunk dangerous nutritional dogmas. Until we do, we will make little headway in reversing an imminent medical and economic disaster.

Here is to watching the food combinations!



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