Tag Archives: Current Market Tactics

China and Japan weight in on the US debt ceiling debate

October 8, 2013 By in China, Current Market Thoughts, economics, Hong Kong, Japanese development, Recent Market Action, Strategy Tags: , , , , , , , , Leave a comment

China and Japan are our two largest foreign creditors.  Beijing holds $1.3 trillion in Treasury securities and Tokyo $1.1 trillion.  Together, they account for 21% of all public holdings of Treasuries, and 45% of foreign lending to the US government.  So what they say counts for a lot.  Of course, whether they choose to roll over their Treasury exposure as it matures counts for a lot more.

Needless to say, neither is thrilled by the current shenanigans in Washington   …but for different reasons.

Japan is worried that a US default would cause a decline in the US$ and a flight to safety in the ¥.  Japan has spent the last year engineering a sharp depreciation in its currency as part of a last-ditch effort to revive its moribund economy.  The last thing it wants to see is one of the three pillars (or “arrows”) of Abenomics, a weak yen, destroyed.  (On the other hand, there’s still no evidence that the third, and most crucial, arrow–reform of antiquated corporate business practices–will ever leave the quiver.)  What I find interesting about this attitude is that there’s no trace of the deference toward US interests shown by a prior generation of Japanese leaders–men who believed their loss of WWII obligated them to act this way.  No surprise here, except maybe to  politicians in Washington.

China is expressing concern that its very large investment in the US could lose value as a result of political stalemate in Washington.  In itself, this isn’t much of a surprise, either.  China has been working for several years to reduce its exposure to US government debt by spending its large surplus of dollars as fast as it can.  No matter what the outcome of the debt ceiling issue in Washington, Beijing will doubtless redouble its efforts to reduce its Treasury exposure.

The way it has framed its concern, however, should be sending chills down the spines of any US entity with direct investments in China.  Beijing points out that China has large investments under the stewardship of the US–predominantly Treasuries.  Conversely, the US has large investments under the stewardship of China–in the form of manufacturing, distribution and retail ventures that US corporations have established there.  The two governments have reciprocal obligations toward each other.  The US must be a responsible steward of China’s investments; China, in turn, must be a responsible steward of foreign direct investment from the US.

The implication is that US failure in its obligation releases China from its duty.

If I’m understanding China correctly, the negative consequences for US companies with China businesses of the current goings on in Washington may be far greater than I think Wall Street realizes.

If so, very bad for the US.  From a practical standpoint, probably better to get China exposure through the Hang Seng than the S&P.

defaulting on the government debt: what it would mean

October 4, 2013 By in Balance of Payments, bond market, currency effects, Current Market Thoughts, Recent Market Action, reserve currency, securities markets Tags: , , , , , , , , , Leave a comment

debt ceiling crunch time

According to the Washington Post, the letter Treasury Secretary Jack Lew recently sent to Congress said that in mid-October, the Treasury will reach the legislatively imposed upper bound on borrowing to pay for goods and services that Congress has ordered up.   That’s a problem, because Washington’s spending so far this year has exceeded its income by about $100 billion a month–and that’s even after the sequester kicked in.

D-Day is October 17th.

The Treasury figures it will have $30 billion on hand on that date.  Bills coming due can reach as high as $60 billion in a single day.  The current layoff of large numbers of Federal employees through the Tea Party-created shutdown might “save” $5 billion a month, but that doesn’t move the needle much.

what if Congress doesn’t act?

If Congress doesn’t raise the debt ceiling, two related problems arise:

–someone has to decide who gets paid and who doesn’t.  The biggest chunks of spending are Social Security, Medicare/Medicaid, the military and interest on the Federal debt (which alone averages about $33 billion a month), and

–inevitably there’ll come a day when the till is empty and the Treasury either misses an interest payment or, more likely though a rollover timing issue, a principal repayment on Treasury securities.  That’s a default.

what default would mean

Secretary Lew is saying that a government debt default could/would create an economic crisis bigger than the bank failures of 2008.

Yes, I think the inevitable default that would come from not raising the debt ceiling would be a major shoot-yourself-in-the-foot moment for the country.  Worse than 2008, though?

…unless we’re talking about possible very long-term consequences, I think this is possible but not probable.  On second thought, minimizing the damage would require Congress to realize what an idiotic thing it had done and “cure” (as the technical term goes) the default immediately.  The more reluctance by Washington to do so, the closer to the Lew scenario we get.

Default would have several important negative consequences:

slower economic growth

–by not paying on time, the US would establish itself as an unreliable borrower.  Lenders, both foreign and domestic, would therefore demand a higher interest rate for the use of their money.  How much higher?  That depends a lot on Congress, but basically no one knows.

–given Washington’s dysfunction, the only effective tool of macroeconomic policy the country has is the Fed.  To at least some degree, the Fed would lose its ability to influence rates if investors begin to regard Treasuries as risky securities.  That’s not good.

weaker currency

–the move among emerging countries to replace the dollar as world currency with, say, the renminbi, would kick into higher gear.  This would risk the US losing the perks of being the world’s banker–lower interest rates, ease of borrowing.

–in extreme circumstances, global buyers and sellers might lose enough confidence in the dollar that they’d refuse to accept it in trade.  This might freeze global commerce in the same way that was so devastating to the world in late 2008-early 2009, when firms wouldn’t take bank letters of credit.  That could be really ugly.

 

There is, of course, the issue that adding $1 trillion+ a year to the Federal debt isn’t a sustainable plan for financing the Federal government.  And business-as-usual Washington has no tolerance for addressing the holy trinity of budget-busters–the military, Social Security and Medicare/Medicaid.  Still, puling the house down around everyone’s ears isn’t a great solution, either.

 

 

October could be a tricky month–but for unusual reasons

September 30, 2013 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management Tags: , , , , , , , , , Leave a comment

October selling

Seasonal weakness usually hits the US equity market in late September and continues through the first half of October.  The reason is tax selling by mutual funds and, to a much lesser degree, ETFs.

mutual fund/ETF tax planning

A mutual fund or an ETF is a special kind of  corporation that is exempt from income tax on any profits it makes, provided that it sticks to portfolio investing and distributes to shareholders basically all realized gains.  These payouts become taxable income to their recipients.

For every mutual fund or ETF I know, the fiscal year ends on Halloween.  That’s when the fund has to figure out its gains and make the required distributions.  This has nothing to do with trick or treating.  It’s October so the fund can close its books and send out the distributions before December.

Funds typically begin to prepare for their yearend in late September.  They either sell winners so they can make a distribution (for some reason, shareholders regard distributions as a good thing), or they sell losers, to use the tax losses this creates and to keep the distribution down to a reasonable size.

Not this year, though.  In fact, not since 2009.  As far as I can see, most mutual funds/ETFs still have considerable accumulated tax losses on their balance sheets.  Those resulted from the massive panic-induced redemptions that occurred at or near the bottom of the market in early 2009.  The losses, which offset realized gains, will swamp any profits funds may have made this year.  So there’s no point to doing normal year-end tax selling until past years’ accumulated losses are either used up or expire.

this year’s issue is different

It’s budget negotiations in Congress.

spending power

One negotiation, whose deadline for action is tonight, is over Congress giving the administration authorization to spend money to run the Federal government.  Talks are deadlocked.  Absent a last-minute compromise, an estimated 800,000-1,000,000 government workers will be furloughed effective tomorrow.  That’s out of 2.1 million Federal employees.

The furloughs would add about .6% to unemployment in the US.  They would also have negative economic ripple effects, as corporations that do business with Washington defer spending plans while they wait for the situation to develop.

According to USA Today, the Federal government has shut down 17 times since 1977, though usually only for very short periods of time.

borrowing power

The second, and more important, negotiation is on raising the Federal debt ceiling.

Washington currently borrows about 20¢ of every dollar it spends.  The Treasury estimates it will reach the limit of its current borrowing authority from Congress in mid-October.  Without an increase, the government will be reduced to spending only money that comes in the door from taxes and other payments.

At some point, it’s possible that the Treasury wouldn’t have enough money on hand to make interest payments on the Federal debt or redeem Treasury securities that come due–meaning the US would be forced to default on its debt.  That would be awful.

Wall Street worries

I don’t think Wall Street–and any other world stock market–will find it easy to move up during a period of uncertainty like this one.

The main issue, of course, isn’t the looming government shutdown.  The longest happened during the Clinton administration–twice.  The S&P fell modestly, and quickly regained lost ground after the shutdowns ended.

It’s the question of whether the crazy behavior of Congress in causing the shutdown will be repeated in the debt ceiling talks, where the stakes are much higher.

Personally, I can’t decide whether the Tea Party Republicans who are at the core of the disputes are content to bring the government to edge of disaster before compromising, or whether they want to go further.  After all, in March 2009, a group of similar-minded Republicans voted against the bank bailout, saying they would prefer a repeat of the Great Depression of the 1930s to pumping money into bankrupt financial institutions.  The S&P fell by 7% on that news.  Then the Republicans changed their minds.

That was a great buying opportunity for stocks.  Hopefully, we won’t have another one.  But uncertainty will likely keep a lid on the market until the debt ceiling issue is settled.

what I’m doing

From a strategic point of view, I think the best course is to believe that politics will eventually work itself out and to not change portfolio positioning.

My tactical view is a little different.

In times like this, short-term traders tend to argue that if the market can’t go up, there’s only one direction it can move in.  So the lack of upward potential implies downside pressure.

That make me a buyer on weakness.

Baby Boomers: wounded by the Great Recession

September 25, 2013 By in economics, Strategy Tags: , , , , , , , , Leave a comment

Yesterday I wrote about Tyler Cowen’s semi-apocalyptic vision (if semi-apocalyptic is possible) of the US in the upcoming years.  His bottom line is that a small minority of tech-savvy Millennials will prosper while everyone else stagnates, distracting themselves all the while with their smartphones and video games.

A bit over the top?   …probably.  But maybe I should be nicer to my children, just in case.

There is, however, a much more straightforward way in which the economic environment since 2008 has been damaging to the Baby Boom and beneficial to Generation X and to Millennials.

It’s monetary policy.

When times are good, savers/lenders get a positive real return on their money.  That is, they receive interest income that compensates them for the effects of inflation + an extra percentage point to three or more, depending on how long the loan is or how creditworthy the borrower is.  When times are bad, the central bank steps in and pushes interest rates down below the rate of inflation to encourage borrowing and spending.  So returns on loans shrink, both in real and nominal terms.

Put another way, the central bank stimulates economic activity by taking money out of the hands of people who are loathe to consume and putting in into the hands of ardent spenders.  Senior citizens and the wealthy get dinged; the young and the willing-to-become-indebted have a field day.

That’s just the way macroeconomics works.  The elderly suffer for the greater good of the overall economy.

Three things are unusual–and unusually damaging to the Baby Boom generation–about the Great Recession:

1.  the biggest is the length of time fixed income yields have been depressed.  In a garden variety recession, the pain lasts a year or so.  But we’re now in year five of depressed interest interest rates, with the prospect of normal returns not reappearing until 2018.  Ouch!!!   That’s a decade of the old subsidizing the young.

2.  there’s also the amount by which yields have been depressed.  On the 10-year bond, it’s 300 basis points; on the 2-year note, it’s 350+bp.

3.  finally, there’s the fact that short-term rates have been reduced to zero.

Yes, arguably a real return of negative 2% is a real return of negative 2% whether the nominal return achieved is 3% (meaning inflation is 5%) or zero.  But there’s at least a sharp psychological difference between getting a monthly check for $2500 and one for $20.  And I’m not sure how people generally feel or behave when they’ve got to sell assets to meet living expenses–whether people can mitigate the negative effect on well-being by making substitutions.   Certainly you can’t substitute your way into making $20 go as far as $2500.

My point?

The money policy consequences of the Great Recession are just one more factor hastening the changing of the guard, in economic and stock market terms, away from the Baby Boom, and toward younger consumers.