Quarterly Newsletter - October 2011
Major Indices (as of 1/10/2011)
* PE ratios (based on historical
Commentary – Past 3 months
The past 3 months saw most share markets globally fall severely (as much as 25% in Germany) , and about 20% in Australia and the USA. The Aussie dollar also dropped about 10%, as global confidence weakened on fears over US and European debt problems and stalling Western economies. A Global recession or severe slowdown appears inevitable in the Western world that is if you believe we ever got out of the 2008-2009 Global recession.
Global share market Price to Earnings (PE) ratios are significantly lower and are generally at low valuations. The problem is Global debts; fears (and soon earnings) are all worsening. Perhaps time to start looking again at growth regions (developing countries and resources) which are now very undervalued.
Global exports are slowing and economists are concerned about global debt levels.
US employment is flat still hovering stubbornly at around 9% unemployed and Australia around 5.3% unemployed has increased despite the mining boom.
Europe and UK are still awash with debt particularly in the PIGS countries supported only by Germany and France. Their economies are weak. Europe is about to crack!
China and India continue to do well, however there is growing concern with Chinese exports slowing and arguably a property bubble in the major cities. India is probably better shielded during a Global depression/correction. An IMF GDP forecast for 2012 of 9.0% and 7.5% growth respectively. Still impressive growth.
SE Asia and ASEAN continued strongly with the Philippines a top performer with 7.3% GDP growth and about 35% rise in share markets and 20% rises in property markets last year. The Makati CBD skyline is filled with new cranes and skyscrapers under construction. No GFC here.
The Baltic Dry Index (BDI) has recently moved up slightly to 1,927 but remains weak.
US retail sales forecasts are steady.
Global GDP is still low in all the western countries (especially bad in Europe and UK) with most of them hovering around 0-2.0%, almost slipping into recession, with optimistic hopes for world growth in 2012 to reach 4.0% (IMFs September 2011 forecast).
It is definitely a two speed world - the slow developed and booming developing economies.
Global Interest Rates have mostly remained the same with the exception being China rising to 6.56% to slow the property boom and India to 8.25% as both are booming economies. A rather surprising small increase in Europe to 1.5% occurred on July 7 considering Europe's recent economic woes. Brazil has lowered rates from 12.5% to 12%.
Currencies over the quarter were summarized by a fall in the Aussie dollar from its booming highs, The Australian dollar (AUD had reached 1.10 to the US dollar, settling now at $0.97. The Euro and US Dollar declines have halted for now.
The commodities are factoring in for a severe slowdown in growth, with Copper very bearish.
Australian house prices
Australian home prices have fallen slightly again especially in the prestige market. Sydney bucked the trend and remained steady and confidence is shaky at best. Further falls are very possible as the sector is still quite overvalued.
Commentary – Forecast next 6 months
Whilst we have had very significant falls in financial markets the past 3 months I fear that more is still to come, at least in the European markets and US markets. Asian shares and Global Resources may do relatively better, as some great value is appearing here, however Global debt issues will likely continue to cause very negative sentiment until we see these problems begin to be solved either by default or Government austerity plans. Greece will likely default and the European region is in severe crisis. Money printing will just cause currency weakening and inflation.
The Baltic Dry Shipping Index is slightly higher, yet Copper is 30% lower. Mixed signals for a patchy economy.
US Retail sales forecasts are forecasted to be steady. This is suggesting a continuing slow US economy as retail sales make up about 70% of US GDP.
Western (developed countries) share markets are likely to fall further, while emerging country share markets may start to rise, that is if Europe does not totally collapse.
Some market commentators are forecasting that the Dow and Gold will meet at 6,000…. Certainly a worrying thought for US equities (currently 10,913) and good for Gold sitting at 1,626.
The West (developed economies) may likely move sideways for another decade or two while they sort out their debt problems (personal and Government debts), meanwhile the emerging economies that participate successfully in Globalization will become increasingly wealthy. In effect a massive transfer from West to East or a steady equalization of the World over the next 2-3 decades. I see salaries and asset prices being equal between West and East before 2050. See discussion "2020 and 2050 --- What will it be like?"
US and Euro Debt Update – Global slow motion train wreck
The global economy is facing ''a slow-motion train wreck'' with Greece only the first nation to be hit, according to our own Reserve Bank director Warwick McKibbin. Referring to the most recent global economic crisis as a mere ''blip'', he said the coming crisis could undo the mining boom and bring on inflation of the kind not seen since the 1970s.
Professor McKibbin told the Melbourne Institute conference dozens of European countries now had gross government debts on track to exceed 60 per cent of GDP. ''Japan is forecast to be 200 per cent of GDP, the US is forecast to be over 100 per cent of GDP,'' he said.
''At zero interest rates that can be sustained, but at 5 per cent interest rates countries have to put aside 5 per cent of their GDP every year (assuming 100% debt to GDP) just to service the debt. That is not sustainable. "
''Already consumers aren't spending and investors aren't spending because of the tax increases that are in prospect".
''Greece, Portugal and Ireland don't just need to have their debts written off, they need to have a 30 per cent to 40 per cent depreciation of their real exchange rate,'' he told the conference.
''There are two ways to do that, either pull out of the euro and depreciate by 40 per cent, or have deflation of 40 per cent over the next 12 months.
''I do not believe any society can survive having a 40 per cent deflation that's been imposed by the International Monetary Fund and the European Central Bank.''As the US created more dollars to inflate away its debt repayment obligations, countries that are linked to the dollar, including China, India and parts of Latin America, would suffer 1970s-style inflation. ''In India inflation is 9 per cent, in China it is 6 per cent. That inflation is pushing up resource prices for now, but it will have to be brought under control with much higher interest rates,'' he said.
Government Public Debt as a Percentage of Country GDP
The key is can a country sustain its debts and its interest payments on its debts.
Remember also that Governments have a lot of other obligations- Government workers, infrastructure, schools, health, retirement benefits, defense spending etc.
In summary, the above debt charts show the countries that are in trouble. The middle chart, "Net Debt/ GDP , probably gives the best summary of the countries in trouble. Japan is not there but is the worst followed by Greece, Italy, and Ireland etc. Europe is arguably in more trouble than the US; however the US seems less keen to make the necessary changes to fix the debt problem. The other huge problems of unfunded future obligations in US Government pensions, health costs etc can be solved by new policies and mostly impact the US retirees.
US Government Debt and Default
The US Government owes exactly $14,695,102,108,238.02 (14.7 Trillion) as of Sept 30, 2011.
Of this 14.6 Trillion, about $4.6 Trillion is owed to foreigners; $6 Trillion is owed to itself to fund various accounts to pay retirement benefits for government workers, social security and unemployment benefits.
Chances are getting higher every year that the US may default on their loans (mostly to the Chinese), or more likely the Government may cease to pay, or drastically be forced to reduce its obligations such as pensions, salaries, Medicaid etc. This may lead to social unrest, riots, and a toppling of the US Government.
After the 2012 US elections it is hoped that the new Government (? Republicans) would likely start to reduce the mountain of debt by slashing Government spending on the military, and social welfare as well as cutting spending by reducing the size of the Government as well as broader and higher taxes. Unless the US can quickly get this debt under control (the 14.6 trillion is approaching 100% of GDP now), the US dollar would collapse and the yields on US Bonds and other debt would be much higher, or only available on long term bonds to allow the yields to remain at a level that the US can afford to pay the interest and stay afloat.
History shows us countries can survive after default. In 1998 Russia defaulted on $40billion of debt and massively devalued the Ruble. Today just 13 years later Russia is strong again thanks to oil.
Of course if the US Government should drastically cut spending then US bankruptcy could be avoided. This will be difficult as the US Government has only run a surplus 4 times in the past 50 years, and Obama and the Democrats love to spend to win votes. Luckily the Republicans and the Tea Party are fighting hard to cut Government spending. The graph below shows the debt problems can still be solved if swift hard action is taken.
Five solutions to the West's Debt woes and the Global Financial Crisis
See table example below.
Effect on US/China Salaries and Debt/Surplus if the US dollar devalued by 50% and China salaries double.
NB: In 2011, 1 USD = 6.44 Chinese Yuan, after Devaluation 1 USD = 3.22 Yuan
NB: China would in Yuan terms lose half its US invested surplus, however would have a much stronger currency and be able to purchase global goods much cheaper helping to promote Chinese buying from US, and Chinese minimum salary ($60) will be almost equal the US ($80), solving the current imbalances of jobs and trade, and leaving Chinese salaries 4x higher in USD terms.
If the US was to devalue the dollar by 50% then its debt would be relative to all other currencies 50% less and perhaps the US could climb out of its debt hole. That is, the interest bill and the debt on the US debt would drop in half as far as China is concerned—a bitter pill to swallow, but better than a default. The US economy would be competitive again and be able to sell goods globally.
The long term solution to the woes of the World lies in equalizing the salaries of the West and East as soon as possible. This can be done by currency devaluations in the West (currency strengthening in the East) and salary increases in the East. This will help solve the debt problems and restore the balance to world trade.
Simply devaluing Western (developed countries) currencies by 50% (or increasing Eastern (Emerging countries) currencies by 100%), and doubling the minimum daily wage in Emerging countries can be a solution to the Global financial crisis and also help solve Global poverty.This is outlined in my Powerpoint presentation on my website under 'Global Crisis Solutions'.
US Credit Markets will always be in debt while the USD is the Reserve Currency – The Gold Standard as an alternative
Total US Credit Market Debt (both Government (14.6 Trillion), and Private debt at 31 March 2011, is $52.63 trillion. This is primarily because after US President Nixon decided to abandon the Gold Standard (ie 1 USD = 35 ounces(Oz) of Gold) in 1971, (the Gold Standard had been operating very well for 254 years since introduced by Sir Isaac Newton established in 1717), the US Dollar (USD) became the world's reserve currency and the US started printing USD at too fast a rate.. Today 1 USD buys you just 1/1650th of an ounce of gold. (NB: 1 gram (g) =0.035273 Oz or 1 Oz ~ 28.4g)
NB: or 1g Gold = $60 USD
As populations grow and more US currency is needed for society then the US just prints money and sells it in the name of US Bonds etc. The main problem with this is that the US can overprint money and create too much global debt. This then causes inflation, global debt overload, and eventually (starting now) inability to pay the interest on that debt, or at least the interest payments depress the economy.
Future Gold Coins and Notes (assumes 1gram of gold in a coin = $60 USD)
I would suggest that the US only print new money which contains the above set amount of Gold. This would limit money printing and help return the world's monetary system to order.
The table below gives a summary and breakdown of the various US debts and the interest required to meet these debts. Of note, the interest payment on the foreign debt (4.6 T) is only USD 1.25 per US citizen per day---quite affordable really. The bigger problem really is the Government trying to pay for the promised future obligations of Medicaid, retirement pensions, and other.
Another solution is for the IMF to control the rate at which the "World Reserve" (USD) currency is printed, to control inflation. International supervision over the issue of U.S. dollars should be introduced. The safest for this to happen is to have a global reserve applicable to all currencies which will help the monetary system from being captive to just one currency – the USD.
US Private Debt to GDP ratio
The two Graphs below tell us a lot about why the GFC occurred and what will happen next. US private debt to GDP ratio was approaching 300%. This meant that the US consumer was so indebted that they could no longer afford to consume---which then lead to US GDP dropping drastically--- and a recession/depression(GFC). By comparison Australian Private Debt was not so high, and wages and employment thanks to the resources boom remained strong.
Comparing to the Great Depression the Graph below tells us that once Private Debt rises above 150% to GDP (or about 250% in the GFC as interest rates were very low at that time), the consumer can no longer spend and the economy slows and slips into recession/depression peaking at around 250-300% private debt/GDP.. The recovery in growth occurs once the Private Debt to GDP ratio starts to decline--- the more it declines the more growth picks up. Note the inverse relationship between the black and blue lines in the chart below.So a key measurement of when the economy is ready to recover is when Private Debt to GDP declines. If it continues to decline back to more acceptable levels say below 150% to GDP then the consumer can now afford to spend again. The above chart shows some hope as the Private Debt/GDP ratio is declining now in the US… Should this continue and the US Private Debt/GDP ratio gets below 200% then it may be time to consider buying equities again. Perhaps this may occur in 2012 with a new US President and some much needed US Government debt reductions also.
The Graph below compares the various types of US Debts/GDP ratios now and over the last century and during the Great Depression.
What it tells me is that the real problem for the US economy and most Western economies today is the Household (Private) and Finance (Banking) Debt levels are way too high. The recent large drop in Finance debt was really taken over by the US Government bailouts.
To quote from economist Steve Keen, "But households are in far worse shape now than in the 1930s, with a peak debt level that is two and a half times as high as it was in 1930. That's why the crisis now is manifesting itself in stagnant consumer demand. It doesn't involve the same plunge into deflation as the Great Depression, but it does imply a more drawn out deleveraging, because it's much harder for households to reduce debt than it is for businesses. Businesses can get out of debt by going bankrupt, sacking workers, and stopping investment. Households have to live with the shame of bankruptcy and the limitations it imposes on behavior in future, they can't sack the kids, and it's impossible to stop consuming completely. So we may face a far more drawn out process of deleveraging than the Great Depression.
The US Government debt can be paid down if in 2012 they get a good Government--- this will be a pivotal time for the US and the World economy.
Most likely is we will see a decade where the indebted Developed economies struggle to grow, while the Developing economies continue to catch up. Personally, I would like to see this process sped up with currency falls in the Developed indebted countries, and wage increases in the Emerging countries. Once World minimum wages equalize the World will be a much better place for all --- investors and the poor.
US Sector Debt/GDP ratios
Take away lessons
2020 and 2050 --- What will it be like?
In this October issue of the HNW Financial Advising newsletter, I take a look at what the world will be like it 2020 and 2050.
This follows on from the July 2011 newsletter where I looked at 2050 as the likely time by which the world's economies (that participate successfully in globalization) should have largely equalized. The main consequences of that were expected to be an equalization of asset prices between the East and West. The smart investor therefore will be buying up assets now in the East and trimming down Western assets.
Globalization – What are the consequences for 2020?
In summary, by 2020, I expect to see jobs, wages, inflation, savings and asset prices all a lot higher in the East and not much changed in the West. Judging by the table below wages in the East should increase by 150% by 2020, compared to a meager 20% increase in the West by 2020. This is because companies will continue to use the cheaper labor of the East and continue to globalize goods and services to the cheapest source.
Expected Average Wage Changes Philippines (East) v Australia (West) 2010-2050
The above example roughly assumes wages to increase by 100% each decade in the East compared to just 20% per decade in the west.
To achieve the above outcomes requires asset prices in the East (Philippines in this example) to grow at 10%pa from 2011-2020 and 5%pa from 2020-2050; compared to the West (Sydney) at 3%pa from 2011-2050. If this occurs asset prices in the East and West will have equalized in just 40 years from now in 2050. Off course this could also happen quicker! Quite likely!!!
In summary, by 2020 it is likely that much of the World will have moved heavily away from Oil and towards Electric cars.
Australian house price crash – What are the consequences?
Recently "shorting" (betting it will fail on its debt obligations) the Australian government is among the hottest trades in the credit markets as trading activity of credit default swaps (CDS) referencing the Commonwealth of Australia reached more than $2 billion in just one week. This means big investors are betting on an Australian government debt default.
Chinese Yuan likely to be revalued upwards soon
The upward revaluation of the Chinese Yuan seems imminent as China grapples with inflation and finally decides it is time to allow its currency to be truly free.
How to escape the demise of the West and the GFC
The answer is simple!
My preference is the Philippines as they have the best English skills, a young population, and finally a good Government. Their economy is driven by Overseas Foreign Workers (OFW) (about 9 million of them), sending money home and buying Condos mostly in Manila (about 40,000 per year), and a booming call centre industry like India, as well as manufacturing (electronics). Domestic consumption is increasing as salaries increase.
South America also looks promising --
To find out more please contact an adviser at email@example.com .
NB : High Net Worth Financial Advising attempts to enhance overall return for clients by investing in undervalued regions of the world and undervalued asset classes, that have positive growth stories.
NB : The contents of this newsletter does not constitute personal
advice and is general in nature, please see your adviser for
suitable to your own needs and objectives.