On Being Bullish on Risk Assets and Ayurvedic Life Style Recommendations – Part IV!

From: Aditya Rana
Date: Sat, Jan 11, 2014 at 2:18 PM
Subject: On Being Bullish on Risk Assets and Ayurvedic Life Style Recommendations – Part IV!


As we head into 2014, it is useful to formulate a broad market outlook for the year and Hugh Hendry, the maverick manager of the hedge fund Eclectica, provides a thought provoking insight into what we can expect this year and beyond. By way of background, Hendry has been bearish on markets for a while (even prior to the 2008 financial crisis), and made a particularly prescient (and vocal!) bearish call on Europe well ahead of the Euro crisis of 2010. To summarise his December, 2013 letter (http://www.eclectica-am.com/publications.aspx )to investors:

-In response to the continued stimulus provides by global central bankers, Eclectica has been cutting down its bearish trades and tactically allocating more capital to bullish risk positions.

– It is increasingly clear that the Fed is willing to subordinate the demands of its own economy to the challenges faced by emerging economies.

-The greater risk going forward is not that we get a sharp correction in the U.S. market following tightening by the Fed, but that we get rapidly accelerating prices to the upside.

-Looking at stock market history over the last 113 years, it is clear that trading patterns like we have seen over the last two years invariably end in big boom or crash (or both).

-The markets of 1928, 1982 and 1998 stand out with charts eerily similar to the current episode (see graph below).

-Back in !998, a confluence of events including the Asian financial crisis, the Russian local currency default, the collapse of LTCM and the Y2K scare ensured that the Fed monetary policy was set far to loose for the economy, resulting in a parabolic move to the upside which crushed the bears.

-The Fed is willing to risk another bubble (and crash) to prevent a downward spiral in the Asian neo-mercantilistic economies which have encouraged exports, discouraged imports, controlled capital and managed currencies to build a cushion of FX reserves to reduce reliance on foreign capital. This approach has probably been the main reason behind Asia’s growth miracle since the 1980s, but carries the risk of making their domestic monetary policies very pro-cyclical – which have not (yet) been really tested on the downside.

-The risk is that the developed world becomes unable to increase its debt to buy Asia products and promote growth – and we could be reaching that moment now. The re-leveraging of the U.S. economy since rates started falling in the early 1980s has directly resulted in superior growth in Asia.

-Japan led the path, fuelled by the managed depreciation of the yen in the early eighties in the aftermath of the popping of the Latin American debt bubble. The BOJ created yen and bought U.S. treasuries, with the weak yen resulting in current account surpluses and continued domestic investment. The excess money flowed into the domestic banking system, and foreign capital flowed in as well, attracted by the corporate profits produced by the loose monetary policy and an undervalued exchange rate. Equity prices quadrupled, and then crashed.

-China has been repeating the same pattern since 2004, with cheap land, cheap labour and cheap money producing high returns on capital and trade surpluses, encouraging capital flows from the rest of the world. As per historical experience this should have led to a stronger currency and higher asset prices fuelling higher consumption – however, currency interventions held down the value of the yuan and real interest rates remained negative to fund the investment growth.

-Negative real rates, without a developed welfare system, has forced Chinese residents to save more. Despite a massive growth in the Chinese economy, consumption has fallen as a share of the GDP. The Chinese growth story resembles Kaiser Germany in the 19th century, which pioneered the neo-mercantilism model.

-The Japan and China growth stories have required a donor country which provides the consumption boom – the virtuous cycle starts with the purchase of U.S. treasuries by the Chinese, with the dollar proceeds being recycled by the U.S. banking system into assets, resulting in rising economic activity, rising asset prices and rising leverage fuelling even more borrowing and higher asset prices. Dollars get cycled back into China through rising imports, with currency intervention creating more yuan and requirements for building even more capacity. Asset prices rise everywhere.

-This has been the global situation for a while now, with asset prices becoming more dependent on money creation than economic growth. In a world of neo-mercantilism fundamental investing has little or no merit – the only thing which matters is whether countries continue printing money.

-However, this game could not go on forever and in March 2009 the U.S. rejected the Asian model. Two domestic boom/bust cycles within a decade had left the U.S. with a debt burden almost four times GDP, and record fiscal stimulus and zero overnight rates were not having an impact on the economy. After pleas to revalue the yuan fell on deaf ears, the Fed hit back with QE.

-QE effectively revalued the yuan in real terms, as the money created flowed to EM countries (given the lack of productive investment opportunities in the U.S.). EM countries were forced to intervene in the currency market which created even more domestic money, fuelling even higher local asset prices.

-This strategy has worked only too well (for the U.S.) – total EM debt has risen to $66 trillion which is almost two and half times EM GDP and double the size prevailing at the start of QE. Car sales in China have surpassed the U.S., housing transactions are up 35% annually and new home prices across the country are rising by 15-20% annually. The yuan has also appreciated 30% against the Euro.

-However, the impact on China has been disastrous as its export markets have crumbled – European GDP in yuan terms is down 25% since early 2008, making it difficult for Chinese exports who have also experienced rapidly rising wages. In addition, China has had to invest even more to keep the economy growing – for example (since 2009) China has consumed more concrete to invest in roads, rail, bridges, factory construction and new buildings than the U.S. did during the entire 20th century. Despite this effort, the structural growth rate in China has fallen by over 30%.

-The continued increase in productive capacity in China, coupled with the U.S. and Europe not being able to produce a consumer boom, has created deflationary pressure and led to the lowering of inflation expectations with the 10-year inflation expectation (as derived from the T.I.P.S market) moving below its 200 day moving average in April, 2013 (see chart below). This has historically been a signal to sell equities (and buy them when the reverse happens) – but this time it served as a contrarian indicator to buy equities, as the Fed uses it as a principal benchmark for its tapering decision.

-One of the best investment opportunities today is Japanese stocks – as Japan will struggle to produce incremental GDP necessary to repay its debt load – forcing it to resort to inflation targeting (see chart below) and fiat money printing without limit.

-Historical analysis of booms and subsequent busts tend to support the 25 year rule – i.e. it takes about 25 years for an asset price to recover (after a bust) its previous bubble high – the Dow from 1929 to 1954 (with it touching its 50-year moving average in 1941 when Templeton bought his "penny" stocks and made history), gold from 1980 until 2007, silver (31 years) and oil (24 years to break the $40 handle seen in 1980). The Topix, having recently touched its 50-year moving average, could be due another big move up?

-The Fed began signalling its intent to taper in May, 2013, as it saw that QE had successfully re-distributed global GDP growth from China to the U.S.. However, a sharp move up in U.S. treasuries and a 20% currency devaluation by its fourth-largest trading partner resulted in slower than anticipated growth and forced the Fed to postpone its tapering. Where and when will this all end?

-The most likely outcome is that the U.S. and Europe remain resilient without booming. However, with monetary policies set so loose there are likely to be mini- economic cycles which will scare investors into expecting higher rates which will result in sharp downturns in global markets – EM in particular. But these fears will not materialise as competitive pressure on keeping monetary policies loose to boost growth will rescind such expectations. Markets – including EM – will recover rather than crash. Developed markets could keep trending positively against this background and might even accelerate. "Stay long risk – pretty much anything".

Fascinating and insightful piece, making a compelling argument to stay long global risk assets for now. And start reducing risk as economic growth in the U.S. recovers which could result in a sharp market correction as investors start anticipating higher rates – which would create an attractive buying opportunity. Emphasise Europe, Japan (hedged basis) and select EM (China, India) equities in portfolios.

It’s interesting to note that since QE2 in 2010, the volatility of U.S. macroeconomic data has subsided significantly (see chart below) – a remarkable testament to Bernanke and the Fed’s expertise in managing monetary policy with the objective of producing stable growth. We can expect other central bankers around the world to follow suit.

Ayurvedic Life Style Recommendations – Part IV (Dr. Vasant Lad):

Ayurveda lays great emphasis on maintaining an appropriate lifestyle as a means to enjoying a long and mainly disease free life. Dr. Vasant Lad, a former professor of Ayurveda medicine at Pune University in India, is credited with being one of the pioneers in bringing Ayurveda to the U.S. by founding the non-profit Ayurvedic Institute in New Mexico in 1984 (http://www.ayurveda.com/). He has written numerous books on Ayurveda, and also writes on health in a quarterly publication produced by the Ayurvedic Institute. This is part four of a serialisation of a note he wrote a few years ago on the Ayurvedic recommendations on lifestyle:

Kapha pacifying lifestyle:

-By nature, Kapha is heavy, dull, cool, soft, oily, liquid, static and gross. Kapha people tend to love sweet and salty tastes and they do not like to exercise. They have slow metabolism and easily become overweight. Therefore the main lifestyle recommendation for Kapha dosha is to be active and get daily exercise.

-Kapha is stable, so they need to keep active and challenge themselves mentally by taking on new activities and learning new skills. They should work hard and rest less – i.e. late to bed and early to rise.

-Kapha people can be possessive, overly sentimental and attached to old relationships – they should be ready to let go if required and accept new relationships. They should practice detachment.

-Kapha people should avoid breakfast and eat brunch which becomes the main meal of the day. They can then eat a light and early dinner as their second meal of the day. Most importantly, kapha people should avoid snacking during the day. They should fast once a week, drinking only apple juice, vegetable juice or herbal tea.

-Kapha people should not drink iced or chilled water. Hot herbal teas – green, ginger, cinnamon – are good for Kapha dosha. Alternatively, they can drink a cup of hot water with juice from half a lime along with a teaspoon of honey and 5 to 10 drops of apple cider vinegar. This is a good drink to scrape excess fat from the system.

-A kapha pacifying diet should favour light, warm, spicy foods. The best tastes for kapha are bitter, astringent and pungent, while sweet, sour and salty foods should be avoided.

To be continued.

There will be no newsletter next Saturday as we are shifting houses!

Best wishes for a happy, healthy and prosperous 2014. Stay bullish on global markets!




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