Tuesday, June 22, 2010
Will yuan rise imapacts?
China is running huge surplus against developed countries. China became shop floor of the world. This was made possible by increase in entitlement costs and therefore erosion of competitiveness, improvements in communications and transportation technology, hard work of Chinese labor and political planners. Industries in western countries matured and started providing their workers with huge benefits. Cost of these benefits started tipping the balance of value generated from these industries. Corporate leaders judged for creating shareholders wealth had to scour new ways of reducing costs. Improvements in technology in global shipping and internet have allowed companies to move operations to places where cost of production is cheapest. This resulted in drying up of jobs in manufacturing sector (Middle America) and these jobs moved to eastern side of the globe. This resulted in huge trade surplus. There is one important factor that played role in the de-manufacturing of western countries. It is financial engineering. Western economies have created gigantic consumer societies. These consumers access to credit have gone on binge to finance their purchases of appliances, houses, education, cars and everything. This all was made possible by financial alchemy. Western politicians are asking china to allow their currency to rise. I would say reduce the health care and pension costs. This will tilt the balance of economies. This will reduce unemployment and allow harmony to prevail in the society. Even if china allows yuan to rise to 5 RMB to dollar it is not going to solve problems.
Thursday, June 17, 2010
invisible hand-Greece
Economies around world grow, decay and stagnate throughout the time like eco systems. Macro economic theorists and practitioners study why certain economies grow and some ruin. Adam Smith developed his theories on capitalism, Karl Marx devoted his life in explaining destructive forces inbuilt in capitalism, modern day economists like Keynes supported fiscal activism, and Freidman popularized monetarism. Despite these theories standing as shield against severe crisis, we are seeing economic crisis happening repeatedly. Each crisis is succeeded by a new explanation from new wave of economists. My question is can we indentify the factors that are underlying the crisis. My answer is yes. So how can we achieve this? An economy whose growth accompanies with minimum stress prevails and anything else is bound to fail.
In this article, I would like to think about some economies that have risen into stronger economies like US, UK, Japan, Germany, some economies that have fallen from top like soviet bloc, some Latin American countries and some struggle to survive like Pakistan, Zimbabwe and some African nations.
Civilizations have thrived and destroyed in last two millenniums. We have horde of historians describing rise and fall of Roman Empire, Persian Empire, Chinese civilization, Hindu kingdoms, British Empire, Spanish Empire and so on. As Tolstoy mentioned, “all happy families are alike and each unhappy family is unlike in its own way” the story of rise of all empires is same but fall is different in its own way. Every civilization starts small. Depending on the strength of the people from the civilization, it will start growing. This growth is constantly under check from opposing forces. These forces can be like Barbarians for Roman civilization, Muslim invasions in India, Mongols invasion in China etc. In Modern days, we do not see Empires but Countries, no monarchs but elected or self-appointed leaders to govern. These leaders can safely govern their kingdoms without any fear from barbarian invasions. Therefore, some countries in Europe and Japan have preferred to outsource their defense needs. If so what is the balancing force that ensures each country allocate capital and resources efficiently lest it will ensure its ruin. This force I call as Adam Smith’s invisible hand. This invisible hand takes many forms, activist investor who will punish financially mismanaged countries by limiting its access to capital markets, active public activist who will purge system of mismanagement and so on. Invisible hand is absent most of the time, will manifest itself when system attains deep disequilibrium. So how do we know when system has attained disequilibrium? How long system can remain in disequilibrium. Markets can remain in disequilibrium for longer time than we can ever imagine.
Greece: Greece is a Mediterranean country with great history. This country produced historians like Aristotle and leaders like Alexander. In modern days it has joined European union as a member country by subordinating its currency Drachma to Euro. In return, it enjoyed superior access to global capital markets. This wonderful gift made its politicians to become lax towards fiscal policy. Consequently, country became deeply indebted. As world, growth is increasing so Greece fiscal expenditure is increasing. This expenditure did not help towards developing growth rate of the nation. Therefore, invisible hand turned up in the form of active investors and brought the nation to its waking state.
In this article, I would like to think about some economies that have risen into stronger economies like US, UK, Japan, Germany, some economies that have fallen from top like soviet bloc, some Latin American countries and some struggle to survive like Pakistan, Zimbabwe and some African nations.
Civilizations have thrived and destroyed in last two millenniums. We have horde of historians describing rise and fall of Roman Empire, Persian Empire, Chinese civilization, Hindu kingdoms, British Empire, Spanish Empire and so on. As Tolstoy mentioned, “all happy families are alike and each unhappy family is unlike in its own way” the story of rise of all empires is same but fall is different in its own way. Every civilization starts small. Depending on the strength of the people from the civilization, it will start growing. This growth is constantly under check from opposing forces. These forces can be like Barbarians for Roman civilization, Muslim invasions in India, Mongols invasion in China etc. In Modern days, we do not see Empires but Countries, no monarchs but elected or self-appointed leaders to govern. These leaders can safely govern their kingdoms without any fear from barbarian invasions. Therefore, some countries in Europe and Japan have preferred to outsource their defense needs. If so what is the balancing force that ensures each country allocate capital and resources efficiently lest it will ensure its ruin. This force I call as Adam Smith’s invisible hand. This invisible hand takes many forms, activist investor who will punish financially mismanaged countries by limiting its access to capital markets, active public activist who will purge system of mismanagement and so on. Invisible hand is absent most of the time, will manifest itself when system attains deep disequilibrium. So how do we know when system has attained disequilibrium? How long system can remain in disequilibrium. Markets can remain in disequilibrium for longer time than we can ever imagine.
Greece: Greece is a Mediterranean country with great history. This country produced historians like Aristotle and leaders like Alexander. In modern days it has joined European union as a member country by subordinating its currency Drachma to Euro. In return, it enjoyed superior access to global capital markets. This wonderful gift made its politicians to become lax towards fiscal policy. Consequently, country became deeply indebted. As world, growth is increasing so Greece fiscal expenditure is increasing. This expenditure did not help towards developing growth rate of the nation. Therefore, invisible hand turned up in the form of active investors and brought the nation to its waking state.
USD-EU-JPY economies
US recovery drivers are Fiscal stimulus, Exports…. Headwinds will come from stimulus withdrawing.
Most desirable thing here is improvements in housing, employment and foreclosures
EU/ECB sovereign Risk: Greek bailout, stabilization fund are just starters in the fuzzy space of EU zone sovereign risk.
Germany/France banks together have major exposure to PIIGS debt.
Most desirable thing here is transparency and political will to work together.
Emerging Markets
China, India still plagued by property bubble and inflation. Will European slowdown impact export sectors if these roaring tigers.
US recovery happened on the heels of huge doses of monetary and fiscal stimulus. Fed is slowly withdrawing stimulus programs. We are still not out of woods yet, unemployment is stubbornly over 9 %, housing market shows no signs of recovery, and manufacturing is showing a bit of activity.
Will USA and Europe morph into Japan?
I can think of Europe rather than US turning into Japan. Why? Demographics. Europe has a decling trajectory of young population compared to US. Deflation is might take its life but will be smothered by inflation.
EURO Zone Sovereign problems will play out for long time. All politicians expect problems to get resolved on their own. But this is not going to happen. Europe fundamentals are not that sound. Especially, debt laden PIIGS. There will be a decline in the living standards because of austerity measures taken by the peripheral nations. Europe is more vulnerable to deflation due to systematic deleveraging. This will have indirect impact on China and EM nations.
In this kind of macro scenario what kind of action will play out in various asset markets?
Interest rates: Treasury and Bund yields are trading at their lowest levels of 2010 due to sovereign risk and recovery problems. Since April 10y treasuries have fallen almost close to 75 bps. Bond futures traded in CBOT are pricing 124. How low can yields can go from here? I think if Japan stands an example, rates have further room to go down. US debt levels are rising, recovery is not yet on tracks. What can stall yield curve flattening? FED is on perma hold policy. This means short end curve remains very much anchored to low levels. Inflation shows no sign of coming and therefore 10y rates are falling lower. One interesting thing I can see is from option skew markets. Markets are pricing more of falling rates compared to rising rates. What this means to rest of the markets? Housing loan rates will be low but of no use as long as banks are not willing to lend. Then what is the purpose of these low levels. What are treasury investors looking for? I can think of only one thing, central banks are getting richer for their UST holdings and getting more money for strong dollar.
I can think of another 50 bps rally before any sell off to occur.
Yield curves to flatten further instead of steepening
Fundamentals in rates markets, High level of treasury debt and expected US growth are pointing towards bearish view in the market. But sovereign risk is playing dominant role. So markets need to reach a stage where sovereign risk is no longer threat but the unsustainable debt is bigger threat.
In Forex markets, USD will be crowned as king not because of its best traits but better traits when compared to other currencies. Dollar is benefiting from better growth and removal of liquidity measures.
EURO will attain its nirvana by attaining parity to dollar.
JPY might fall further due to increased purchasing of non JPY assets and further QE
Most desirable thing here is improvements in housing, employment and foreclosures
EU/ECB sovereign Risk: Greek bailout, stabilization fund are just starters in the fuzzy space of EU zone sovereign risk.
Germany/France banks together have major exposure to PIIGS debt.
Most desirable thing here is transparency and political will to work together.
Emerging Markets
China, India still plagued by property bubble and inflation. Will European slowdown impact export sectors if these roaring tigers.
US recovery happened on the heels of huge doses of monetary and fiscal stimulus. Fed is slowly withdrawing stimulus programs. We are still not out of woods yet, unemployment is stubbornly over 9 %, housing market shows no signs of recovery, and manufacturing is showing a bit of activity.
Will USA and Europe morph into Japan?
I can think of Europe rather than US turning into Japan. Why? Demographics. Europe has a decling trajectory of young population compared to US. Deflation is might take its life but will be smothered by inflation.
EURO Zone Sovereign problems will play out for long time. All politicians expect problems to get resolved on their own. But this is not going to happen. Europe fundamentals are not that sound. Especially, debt laden PIIGS. There will be a decline in the living standards because of austerity measures taken by the peripheral nations. Europe is more vulnerable to deflation due to systematic deleveraging. This will have indirect impact on China and EM nations.
In this kind of macro scenario what kind of action will play out in various asset markets?
Interest rates: Treasury and Bund yields are trading at their lowest levels of 2010 due to sovereign risk and recovery problems. Since April 10y treasuries have fallen almost close to 75 bps. Bond futures traded in CBOT are pricing 124. How low can yields can go from here? I think if Japan stands an example, rates have further room to go down. US debt levels are rising, recovery is not yet on tracks. What can stall yield curve flattening? FED is on perma hold policy. This means short end curve remains very much anchored to low levels. Inflation shows no sign of coming and therefore 10y rates are falling lower. One interesting thing I can see is from option skew markets. Markets are pricing more of falling rates compared to rising rates. What this means to rest of the markets? Housing loan rates will be low but of no use as long as banks are not willing to lend. Then what is the purpose of these low levels. What are treasury investors looking for? I can think of only one thing, central banks are getting richer for their UST holdings and getting more money for strong dollar.
I can think of another 50 bps rally before any sell off to occur.
Yield curves to flatten further instead of steepening
Fundamentals in rates markets, High level of treasury debt and expected US growth are pointing towards bearish view in the market. But sovereign risk is playing dominant role. So markets need to reach a stage where sovereign risk is no longer threat but the unsustainable debt is bigger threat.
In Forex markets, USD will be crowned as king not because of its best traits but better traits when compared to other currencies. Dollar is benefiting from better growth and removal of liquidity measures.
EURO will attain its nirvana by attaining parity to dollar.
JPY might fall further due to increased purchasing of non JPY assets and further QE
Wednesday, June 16, 2010
Buy SPY,FXE puts
Everywhere talk of recovery and at the same time talk of stalling market rally happening. Folks like Jim Cramer are questioning the sharp rally happening in risk markets. Market is shrugging of bad reports and inching forward on small good reports. Turmoil in Europe, Housing doldrums in US and unimagined impact in emerging markets are forming the main events of the current act. Back drop is still peppered by deep sovereign deficits in developed economies and surplus in developing economies.
Today housing starts report printed 593,000 units. This is a 10% drop from month of April 2010. Starts of single family homes fell 17.2%. This number vindicates the fact that government’s tax rebate of 8000 dollars effect started fading. Construction industry folks are saying housing industry is still in dire straits. Lack of financing new projects is main bottleneck. Banks are not interested in getting into this high risky business in current environment due to expected losses. Housing starts normally acts as leading indicator of economic growth. Since this indicator is flashing red, economic recovery looks not a feasible outcome. My recommendation would be to buy SPY OTM puts.
Spaniards are occupied with world cup foot ball games although the country is sinking due to crisis in public finances similar to Greece. So what is really going on here? Euro zone governments came together and pooled together 950 billion dollars as a stability fund to bailout nations that are having difficulty in accessing capital markets. In May, Greece managed to get the funding issues resolved temporarily. Although, Greece is not out of woods yet. Now Spain came along with its problem of debt problems. In fact Spain took austere measure to bring the deficit down. These measures will not only bring the debt burden but also bring down the prospective tax revenue. In this situation only thing can help not in short term is to improve the competitiveness in the market. Spain is not alone in the world. If Spain goes down then along with it many other economies have to go down. First order effect will be on Euro. Euro has to depreciate further against dollar. Along with Europe its primary trading partners in emerging markets (India and china) will face a slow down. This means a contagion effect will kick start and economies around the world will again face show down. This time central banks that have already flooded market with liquidity need to employ financial engineering to bootstrap the economies from the brink of disaster. Can they? I think they might get lucky again. In the mean time I will recommend FXE puts to monetize the euro dollar parity.
Today housing starts report printed 593,000 units. This is a 10% drop from month of April 2010. Starts of single family homes fell 17.2%. This number vindicates the fact that government’s tax rebate of 8000 dollars effect started fading. Construction industry folks are saying housing industry is still in dire straits. Lack of financing new projects is main bottleneck. Banks are not interested in getting into this high risky business in current environment due to expected losses. Housing starts normally acts as leading indicator of economic growth. Since this indicator is flashing red, economic recovery looks not a feasible outcome. My recommendation would be to buy SPY OTM puts.
Spaniards are occupied with world cup foot ball games although the country is sinking due to crisis in public finances similar to Greece. So what is really going on here? Euro zone governments came together and pooled together 950 billion dollars as a stability fund to bailout nations that are having difficulty in accessing capital markets. In May, Greece managed to get the funding issues resolved temporarily. Although, Greece is not out of woods yet. Now Spain came along with its problem of debt problems. In fact Spain took austere measure to bring the deficit down. These measures will not only bring the debt burden but also bring down the prospective tax revenue. In this situation only thing can help not in short term is to improve the competitiveness in the market. Spain is not alone in the world. If Spain goes down then along with it many other economies have to go down. First order effect will be on Euro. Euro has to depreciate further against dollar. Along with Europe its primary trading partners in emerging markets (India and china) will face a slow down. This means a contagion effect will kick start and economies around the world will again face show down. This time central banks that have already flooded market with liquidity need to employ financial engineering to bootstrap the economies from the brink of disaster. Can they? I think they might get lucky again. In the mean time I will recommend FXE puts to monetize the euro dollar parity.
Monday, June 14, 2010
invisible hand
Economic growth comprises developments in labor, housing, Manufacturing, service and consumer sectors. These sectors fluctuate in response to business cycles hence causing gyrations in GDP (gross domestic product). Some sectors grow and some lag behind. After housing sector bust contribution from this sector to GDP has been negative to lower. Again changes in each sector are monitored by sector specific indicators. Housing starts, existing home sales etc give an indication of expected growth in economy. Economic growth is most important to every human being that demands resources from another human being or institution.
Economic growth in each country exerts pressure on goods demand and supply. This pressure flows through international channels of goods and cash (credit). Demand and supply concerns determine the price of goods like OIL/GOLD/COPPER etc in global capital markets. Cash (credit) pricing is done similarly. In today’s world Goods, cash (credit) and growth are intertwined in such a way that change in each sector has reflexive effect on other market. Central banks and governments play role in directing economic growth through their policies by becoming a visible hand in regulating the welfare of society. Welfare of society is achieved by invisible hand that regulates responses of human beings to most optimal state and this is nothing but technology or innovation or financial crisis.
Why is credit important? Global economy is driven by buying assets today and paying for tomorrow. This can happen only when some have cash to lend and some are willing to borrow. US GDP in first decade of 21st century is driven by credit related purchases. People here owe everything to credit.
T
Economic growth in each country exerts pressure on goods demand and supply. This pressure flows through international channels of goods and cash (credit). Demand and supply concerns determine the price of goods like OIL/GOLD/COPPER etc in global capital markets. Cash (credit) pricing is done similarly. In today’s world Goods, cash (credit) and growth are intertwined in such a way that change in each sector has reflexive effect on other market. Central banks and governments play role in directing economic growth through their policies by becoming a visible hand in regulating the welfare of society. Welfare of society is achieved by invisible hand that regulates responses of human beings to most optimal state and this is nothing but technology or innovation or financial crisis.
Why is credit important? Global economy is driven by buying assets today and paying for tomorrow. This can happen only when some have cash to lend and some are willing to borrow. US GDP in first decade of 21st century is driven by credit related purchases. People here owe everything to credit.
T
Tuesday, April 27, 2010
Goldman senate hearing
GoldMan Sachs senate testimony:
This morning, star line from goldman descended to capitol hill and started firing at senators. It has clarified the meaning of market maker, complicated mortgage markets and its multifaceted relations with rating agencies. In the end what has happened senate helped goldman to explain their situation live on tv.
From Calculatedriskblog.com there is a wonderful summary of what has happened this morning
"You want the truth? You can't handle the truth. Son, we live in a country with an investment gap. And that gap needs to be filled by men with money. Who's gonna do it? You? You, Middle Class Consumer? Goldman Sachs has a greater responsibility than you can possibly fathom. You weep for Lehman and you curse derivatives. You have that luxury. You have the luxury of not knowing what we know: that Lehman's death, while tragic, probably saved the financial system. And that Goldman's existence, while grotesque and incomprehensible to you, saves pension funds. You don't want the truth. Because deep down, in places you don't talk about at parties, you want us to fill that investment gap. You need us to fill that gap. "We use words like credit default swaps, collateralized debt obligation, and securitization? We use these words as the backbone of a life spent investing in something. You use 'em as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it! We'd rather you just said thank you and paid your taxes on time. Otherwise, we suggest you get an account and start trading. Either way, we don't give a damn what you think you're entitled to!"
I have executed bear put spreads hoping senate will grill our famous ABACUS originators. At the end of day my trade went into red as senators got trained investing in CDOS. Most important irony today is Greek crisis tanked markets around the world. World took refuge in Gold (precious metal). Coincidentally, Goldman stock rose 2%/.
This proves Goldman is equivalent of Gold. Any doubts?
This morning, star line from goldman descended to capitol hill and started firing at senators. It has clarified the meaning of market maker, complicated mortgage markets and its multifaceted relations with rating agencies. In the end what has happened senate helped goldman to explain their situation live on tv.
From Calculatedriskblog.com there is a wonderful summary of what has happened this morning
"You want the truth? You can't handle the truth. Son, we live in a country with an investment gap. And that gap needs to be filled by men with money. Who's gonna do it? You? You, Middle Class Consumer? Goldman Sachs has a greater responsibility than you can possibly fathom. You weep for Lehman and you curse derivatives. You have that luxury. You have the luxury of not knowing what we know: that Lehman's death, while tragic, probably saved the financial system. And that Goldman's existence, while grotesque and incomprehensible to you, saves pension funds. You don't want the truth. Because deep down, in places you don't talk about at parties, you want us to fill that investment gap. You need us to fill that gap. "We use words like credit default swaps, collateralized debt obligation, and securitization? We use these words as the backbone of a life spent investing in something. You use 'em as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it! We'd rather you just said thank you and paid your taxes on time. Otherwise, we suggest you get an account and start trading. Either way, we don't give a damn what you think you're entitled to!"
I have executed bear put spreads hoping senate will grill our famous ABACUS originators. At the end of day my trade went into red as senators got trained investing in CDOS. Most important irony today is Greek crisis tanked markets around the world. World took refuge in Gold (precious metal). Coincidentally, Goldman stock rose 2%/.
This proves Goldman is equivalent of Gold. Any doubts?
Wednesday, April 21, 2010
Market Movements
Markets react to daily news like humans react to various events daily. For instance, we greet a person warmly if we like him and give a look of grin when we dislike a person. These are very natural reactions. Markets also react in the same way. If dollar strengthens oil goes down, good earnings follows good equity market response etc. These reactions are like explaining the market movements in terms of events happened on the day. But markets are like flowing river that musters its force from the under currents it is accumulating. This under current is determined by the fundamental demand and supply factors. For instance Gold Markets. Gold was trading at under 1000 dollars but today it is looking for direction at 1150 levels.
Great Recession has brought unprecedented crisis mitigating efforts by governments around the world. In this effort, huge fiscal stimulus has been pumped into the economy. This stimulus is due to creation of money by central banks. This binge printing made investors scared of loosing value of their paper assets. Investors felt may be world is heading towards the direction of Zimbabwe. So, everybody wanted to convert their assets to physical assets and Gold satiated their appetite. So the price shift that occurred in the Gold is due to this fear of loss of asset values. This did not happen in a day. This process took place over a period of few months. Some days when dollar is rising due to Greece crisis, Gold has risen and other days when Dollar was falling due to Fed’s FOMC statements gold has fallen due to lack of demand in Asia.
Therefore, Gold price movements needs to be viewed in a much higher window and analyzed in the light of both fundamental and technical factors that are driving the price. One thing is definitely sure, in the short run focus on technical movements and long run focus on fundamental factors. This short run and long run determination is an art not science.
Have fun.
Great Recession has brought unprecedented crisis mitigating efforts by governments around the world. In this effort, huge fiscal stimulus has been pumped into the economy. This stimulus is due to creation of money by central banks. This binge printing made investors scared of loosing value of their paper assets. Investors felt may be world is heading towards the direction of Zimbabwe. So, everybody wanted to convert their assets to physical assets and Gold satiated their appetite. So the price shift that occurred in the Gold is due to this fear of loss of asset values. This did not happen in a day. This process took place over a period of few months. Some days when dollar is rising due to Greece crisis, Gold has risen and other days when Dollar was falling due to Fed’s FOMC statements gold has fallen due to lack of demand in Asia.
Therefore, Gold price movements needs to be viewed in a much higher window and analyzed in the light of both fundamental and technical factors that are driving the price. One thing is definitely sure, in the short run focus on technical movements and long run focus on fundamental factors. This short run and long run determination is an art not science.
Have fun.
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