Ideas for 2011

I am not spending much time in the markets these days (very busy with other business issues), but am ruminating over two or three big ideas for 2011.....

1. Sell AUD - yes, the AUD has recently topped out and turned down; with the floods there will be no interest rate rises and a squeeze on consumption (other than construction of course) -- the big issue at hand though is that the currency is simply fundamentally overvalued (just look at housing costs, costs of consumables) and long speculation in the currency has been quite high.  The question is "When do you sell?"....because the catalyst for a major drop will be Chinese production flattening, or declining.....

2. Sell GBP - GBP has bounced down from 1.60 after the GDP figures were released....so interest rate increases will be deferred at the least...the real question is --- shouldn't the looming fiscal cutbacks and tax increases flatten growth, and if the prospects for growth diminish, shouldn't this be reflected in the currency?

3. Sell US equities - all time highs again, not many bargains - do you short this or just stay out for a while?

This is a trading market....the Fed is printing money so paper assets should appreciate, but there has been a good run and it would appear that there should be some pause.....(?)

More color on AUD below:

"The Aussie has lost 3.4 percent for the past month, the worst performer among 10 developed-country currencies, according to Bloomberg Correlation-Weighted Currency Indexes. The currency weakened on concerns floods in the state of Queensland will dent the nation’s economic growth."

Australian Dollar Falls After Consumer Prices Increase Less Than Forecast (from Bloomberg news)

Australia’s dollar is “down a little bit as a consequence of the lower-than-expected CPI because you had a drop in the OIS market,” said Richard Grace, chief currency strategist in Sydney atCommonwealth Bank of Australia.

The Australian dollar fell 0.8 percent to NZ$1.2962 as of 11:30 a.m. in New York. The Aussie dropped to 98.98 U.S. cents from 99.74 cents yesterday.

New Zealand’s dollar, known as the kiwi, gained 0.1 percent to 76.36 U.S. cents.

Australian consumer prices rose 0.4 percent in the fourth quarter from the previous three months, the Bureau of Statistics said in Sydney today. The median estimate of 25 economists surveyed by Bloomberg News was for a 0.7 percent increase.

Swaps Show

Australia’s 12-month overnight index swap rates, a security based on what investors expect the central bank’s rate will average during that period, declined to 4.9790 percent from 5.0180 percent yesterday. The Reserve Bank of Australia left the overnight cash rate target unchanged at 4.75 percent last month.

The Aussie has lost 3.4 percent for the past month, the worst performer among 10 developed-country currencies, according to Bloomberg Correlation-Weighted Currency Indexes. The currency weakened on concerns floods in the state of Queensland will dent the nation’s economic growth.

Demand for the New Zealand dollar increased as the MSCI Asia Pacific Index of stocks rose 0.7 percent.

“Higher stock prices boost appetite for risk and tend to spur buying of commodity-linked currencies,” said Toshiya Yamauchi, a senior currency analyst in Tokyo at Ueda Harlow Ltd.

Fed "Simulation": 3 Million Jobs Created From Bond Buying

It is more than a bit surprising that you now see Fed officials touting "simulations" to make unsupported assertions that their bond purchasing policy will create 3 million jobs!  

And media reaction to this - simply to repeat the assertion and quote some of the usual suspects who disagree, rather than dig a bit deeper into the "simulation", its underlying assumptions and details, is a remarkable dereliction of responsibility...

This is living proof that Dr. Goebbels theory of the Große Lüge is alive and well.  It also shows how obviously political the Fed has become, and how it is being used as a tool of U.S. fiscal policy!  

Conclusion:  this is clearly a signal that the Fed will continue its QE policy, and that it will support this policy by really any means necessary....so -- the task for U.S. asset holders should be to continue to diversify asset holdings, concentrating on those assets which will retain value against a depreciating dollar, over the longer term...

Could be time to put on some positions in CAD, other strong currencies, Gold, Grains, oil stocks...  

From the Wall Street Journal 

By LUCA DI LEO

DENVER -- Federal Reserve Vice Chairwoman Janet Yellen issued one of the strongest and most detailed defenses to date of the Fed's controversial decision to buy more government debt to promote the U.S. economy's recovery.

Illustrating the results of Fed research to an audience of top economists from around the world, Yellen argued the central bank's purchase of U.S. Treasuries is helping boost jobs and prevented a dangerous slide in consumer prices.

"It will not be a panacea, but I believe it will be effective in fostering maximum employment and price stability," Yellen said in prepared remarks Saturday to the annual conference of the American Economic Association.

The Fed's $600 billion bond-buying program, which began in mid-November and is set to run through June, has met strong criticism both in the U.S. and abroad. Even a minority of Fed officials have spoken against. Many economists here have expressed skepticism it will do much to help the U.S. economy, with some warning it may do more harm than good by eventually leading to runaway inflation across the globe.

Yellen responded to each and every criticism, pointing to a recent Fed paper suggesting the bond purchases may help create 700,000 jobs. Together with a previous Fed program, in which the Fed bought mortgage and government bonds in 2009 and early 2010, around three million private-sector jobs may have been added thanks to the central bank's efforts.

The U.S. economy's 18-month-old recovery from the worst recession since the 1930s should speed up this year, Fed Chairman Ben Bernanke Friday told Congress, where some Republicans have attacked the Fed's move for fears it will spark inflation. But it will take many years to make up for all the jobs, Bernanke added, and that's why the Fed's continued support is needed.

The bond purchases, Yellen explained, help the economy by keeping borrowing rates low, driving investors into riskier assets like stocks, and lifting exports by keeping the value of the U.S. dollar low.

Defending the program from criticism it received by foreign officials ranging from Germany to Brazil, Yellen noted the bond purchases have not let to a sharp depreciation of the U.S. dollar as some feared. She said growth in foreign export-led economies should not be hurt if countries take the right measures; on the contrary, the global economy will benefit by an acceleration in the U.S. recovery.

In the program's first phase, when short-term interest rates were close to zero, the Fed purchased $1.25 trillion in mortgage bonds, along with hundreds of millions in agency and Treasury debt. It followed that with a decision to reinvest the proceeds of maturing mortgages into Treasurys. Then, late last year the Fed said it would buy an additional $600 billion in government bonds.

These actions have driven the Fed's balance sheet from around $800 billion at the start of the financial crisis in late 2007, to what the Fed research paper states will be $2.6 trillion by the middle of this year.

The paper came from the San Francisco Fed, where Yellen was president before joining the Fed Board in Washington DC in October 2010. It was authored by the San Francisco Fed's research chief John Williams, along with Federal Reserve Board economists Hess Chung, Jean-Philippe Laforte and David Reifschneider.

By injecting more money with the bond buys, the Fed warded off a dangerous slide into a deflationary environment that would have been caused by the economy's weakness, Yellen said. She expressed confidence that the Fed has the tools to unwind the program and lift interest rates when needed to prevent an accelerating economy from stoking inflation.

Some economists disagree. The Fed's easy money policy is a "serious mistake," according to Ronald McKinnon, a professor at Stanford University, who presented a paper at the AEA-ASSA meetings Friday.

By driving rates so low the Fed has made the global economy less stable, the paper argues, leading to beggar-thy-neighbor policies reminiscent of the international currency chaos that worsened the 1930s Great Depression.

McKinnon draws a parallel with the policies the U.S. followed under President Richard Nixon in the early 1970s, when an easy U.S. monetary policy forced other industrial countries to appreciate their currencies against the dollar, eventually leading to high inflation around the world.

However, other economists at the Denver conference appeared to side with the Fed. Speaking in the same panel as Yellen, Martin Feldstein, a Harvard University professor, said more government support is needed to help an economy that remains too weak to cut unemployment significantly.

Feldstein, a former economic aide of President Ronald Reagan, said the weak housing sector still poses a threat to the recovery because it can seriously hamper consumer spending, banks and the construction sector.

Pared Down Some Positions

With the great December rally in most asset classes, yesterday is was time to take some chips off the table and reassess....

Also relevant is the recent Queensland, Australia flooding of an area the size of Texas -- this will have a great effect on economic output, particularly wheat & coal production and as such will negatively impact the AUD.  Also, with the AUD at highs, things are particularly expensive there and the property market is due for a pullback - when, I do not know, but it looks like the U.S. did to me in 2005...if there is any one bet I would like to make this year it is now to short AUD, however, I will wait for now...

The AUD, CAD, Gold & Corn positions were all very profitable; all came off and a 1% positions in Soybeans was put on.  I will look to add a small position in Wheat if all commodities do not sell off in the near term.  

I am also looking at putting Gold back on and shorting Yen, but again, not yet...

Now flat equities approx. net 0%, gross 25%; equities mostly in defensive sectors for now (Oil stocks & Asian ETFs had a nice run, so lightened up).  The prevailing move in equities is up, so I want to be long, but want to buy cheaper if possible....

Longs in:

Asian ETFs - 2.5%

Pharma - 5%

Telecom - 2.5%

Agriculture - 2.5%

Oil, Gas, Industrials - 2.5%

Tech - 5%

  

Forward PE's on the individual longs are still approximately 11x.

Pending Trades:

Long Gold

Short Yen

Long Wheat

Long Equities (Asian ETFs / Oil Stocks)

Short AUD

The Economics of Inflation

If anyone is interested in learning the details of the great post World War I German hyperinflaiton, they should read at this book.  It is the seminal text on the matter and covers the details of events leading up to the hyperinflation, its causes and of particular interest to me, the social effects - ie, who lost most from the inflaiton and who benefitted.....


It was written in the decade following the events described, and is  incredibly detailed, including a wide array of detailed economic and monetary statistics - inedeed it is more of a text book than a narrative that you would find these days - you must have a strong desire to understand the subject matter, but it is well worth it.


It is hard to believe that hyperinflation could occur in any advanced economy today, particularly with well-documented events of hyperinflation and its horrible results, such as those describedin this book --- however, it seems that the lessons of the German hyperinflaiton (and the high inflations in 1980s Latin America) are not widely understood at all (perhaps QE I & II may end up being examples of this lack of understanding, it remains to be seen).


So, who were the losers?  The "rentiers' or those small business owners, property owners, retirees who had monetary assets....and workers whose wages were not linked to inflaiton...


Who were the winners?  Some large industrialists who owned or had access to foreign assets, currencies, raw material production or importation, speculators (opportunists who had the foresight and flexibility to move monetary assets out of paper currency), farmers (who had mortgage debt which became worthless and who had the flexibility to use earnings from production for machinery, labor and other input purchases).


Take note -- equities did not maintain their value vs the inflation.  Of course, bond investors and those in cash lost it all......

Enjoy !

Adding More Positions

Increased the long equities by 5% (mostly Asian ETFs particularly Singapore):

 

Still modestly long equities approx. net 10%, gross 35%

Longs in:

Asian ETFs - 10%

Pharma - 5%

Telecom - 2.5%

Agriculture - 2.5%

Oil, Gas, Industrials - 5%

Tech - 5%

 

Mar 11 AUD 2%

Mar 11 CAD 2%

Mar 11 Gold 2% 

Dec 11 Corn 1%

 

Forward PE's on the individual longs are approximately 11x.

ETF PE's are a bit higher, however, this trade is more about currency devaluation rather than valuation per se.

To the extent there is a correction, will be adding to the long equity side and possibly the FX side.

 

Still expecting EUR to test 1.329-ish level.

 

Bernanke's Defense of Debt Monetization (ie, Quantitive Easing)

All in all the Fed Chairman's speech is supportive of a weak dollar policy prominent among U.S. government officials, but hitherto unexpressed explicitly....bottom line - keep exposure to fx of resource rich countries and keep long Non-U.S. equities vs short U.S. equities...

Although commentators do not appear surprised by the contents of Bernanke's Frankfurt speech (full text in the link below), I was shocked to read what can only be described as a rather open attack on surplus countries seeking stable exchange rates, and an ode to a weaker dollar.

To start, he states that U.S. debt monetization is "appropriate" because it is a "stimulus" measure as though this were a fact, even though the stated aims of asset inflation are unproven and it is unpredictable as to where the excess liquidity from this exercise will end up (ie, will it end up driving commodity prices higher?).

Additionally, there is a direct reference to the monetization's effect on the U.S. dollar, I believe for the first time:  

"The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies."

However, even though the U.S. is reducing interest rates and thereby lowering the value of its currency, the fault all lies with emerging market countries (ie, China):

"An important driver of the rapid capital inflows to some emerging markets is incomplete adjustment of exchange rates in those economies, which leads investors to anticipate additional returns arising from expected exchange rate appreciation. The exchange rate adjustment is incomplete, in part, because the authorities in some emerging market economies have intervened in foreign exchange markets to prevent or slow the appreciation of their currencies."

Ok - so basically, printing money to buy government bonds to "stimulate" the U.S. economy is ok and not currency manipulation meant to drive down the value of the dollar while emerging market fx stabalization policies are currency manipulation....

Is there any wonder that there is dismay among foreign central bankers at this policy?

Finally, David Rosenberg of Gluskin Sheff has an interesting take, and points out that Bernanke's remarks are entering the political relm.....

So much for Fed independence, the money printing policy very much puts this in the political relm...

From David Rosenberg, Gluskin Sheff:
"Ben Bernanke delivered a speech today in Frankfurt where he pointed the finger at China as a source of global imblance (never mind that the U.S. dollar has collapsed 70% against the yen since I joined the business in the mid-80s and the bilateral trade deficit with Japan hasn't come down one ioata.  Maybe a good part of the imbalance is a U.S. tax code that massively promotes consumption at the expense of savings.)

As an aside, Mr. Bernanke's subtle approval of President Obama's fiscal policies in today's sermon is sure to draw the ire of the new GOP-dominated Congress."

Link to the Full Text of Bernanke's Speech in Frankfurt 19 November 2010

Russell Reynolds 2010 Asset & Wealth Management Trends Report

Interesting report on the state of the wealth management industry from Russell Reynolds, particularly the hedge fund portion of the report...

Interestingly, if the statement below is true, then investors should take heart and go all-in, risk-on...!  Personally, I do not buy it...

"Many investors see current market levels as temporary rather than indicative of a trend, liabilities now significantly outstrip assets and return assumptions far exceed reality. The inflation vs. deflation debate rages on. Indeed, the basis for allocating across a basket of non-correlated assets no longer is an investment cornerstone."

Russell Reynolds 2010 Asset & Wealth Management Trends Report