Category: Stock Markets

From Michael Pettis:

I have often written in this blog and elsewhere about the three policy choices Beijing faces as it tries to manage through the adjustment process. My argument is that subject to two very plausible assumptions, every economic policy Beijing implements ultimately can be abstracted to one choice among three options. These two assumptions are:

1. China has overinvested in infrastructure and manufacturing capacity to such an extent that in the aggregate the cost of additional public sector investment exceeds the present value of future increases in productivity generated by the investment. China’s public-sector investment, in other words, is value destroying, and because it is funded by debt, additional investment causes China’s real debt servicing costs to rise faster than its real debt servicing capacity.
2. China’s long-term sustainable growth rate is substantially below the economy’s current GDP growth target, and so the economy is only able to meet the growth target by increasing its debt burden.

…..any policy Beijing chooses must involve, usually implicitly, some combination of three outcomes. In every case, in other words, we will see as a consequence of the policy one or more of the following:

• Higher unemployment, the limit of which is largely a political issue involving social instability, with the added wrinkle that certain types of unemployment are likely to be perceived as more politically costly than others – e.g. because returning to family farms acts as a kind of safety valve, even though a significant fall in living standards, unemployment among migrant workers is likely to be less costly, or because university graduates are presumably more communicative and have higher expectations, their unemployment might be more costly.
• Higher debt, by which I really mean a higher debt burden, or an increase in debt relative to debt-servicing capacity, and this can rise until credit growth can no longer be forced up to the point where it can be used to roll over existing debt with enough margin fully to fund as much new economic activity that Beijing targets.
• Higher wealth transfers, in which governments – and because the Xi administration is seeking to centralize power this is most likely to involve local governments rather than central government entities – must liquidate assets and use the proceeds directly or indirectly either to increase household wealth or to pay down debt, with the main constraint on Beijing’s ability to direct this process likely to be the tremendous political opposition of the so-called “vested interests”, for whom government control of these assets is an important source of power, patronage, and wealth.

The trade-offs between a higher debt burden, higher unemployment and greater wealth transfers to the household sector may come into sharper relief in 2016 because although unemployment still seems to be fairly low, in spite of much lower growth in the past three years, there is now reason to worry that any additional reduction in growth may begin to show up in the unemployment numbers…..

Centrally-planned economies inevitably get weighed down by cronyism and inefficiencies. Economist Thomas Sowell describes how he used to be a Marxist but working for the federal government cured him of the notion that centralized government could successfully manage anything, let alone the entire economy.

Source: China: Choosing More Debt, More Unemployment, Or Transfers | Michael Pettis’ CHINA FINANCIAL MARKETS

From Francis J. Gavin, Frank Stanton Professor in Nuclear Security Policy Studies at MIT and author of Nuclear Statecraft: History and Strategy in America’s Atomic Age:

It is not always clear in real-time what matters most, though a historical sensibility can sensitize us to look for real-world consequences in unusual places. Will the recent U.S. presidential election seem like the key issue we faced 30 or 40 years from now, when perhaps some deeper, more fundamental shifts (the climate or demographics, for example) or a completely unexpected event shapes the realities of that future world? We don’t know, but it is worth considering.

Relatedly, history conditions decision-makers to understand that policy decisions made in world capitals are often far less important in shaping what matters in the world that other, often less visible historical forces. Culture, technology, demographics, and geography, for example — all are critical forces that are less pliable to policy than we often think.

My favorite examples are three events that took place within a very short period of time: the sale of the early Apple personal computer, the release of Star Wars — the highest grossing motion picture of all time, and the famous 1976 “judgment of Paris” in which previously unknown wines from Napa Valley bested established French wines in a blind taste test. In other words, policymakers in Washington in the mid-1970s who were pouring over economic data, looking at crime statistics and urban crisis, witnessing political chaos abroad, and fearing a Soviet military behemoth that appeared to be winning the arms race had little reason to be optimistic about the future.

But the future was being made elsewhere and in different ways than policymakers understood in places like California, where deep and often obscure historical forces were working to transform the U.S. economy, society, technological base, and culture in ways that would have profound effects on American power and world history.

A deep historical perspective should also allow the decision-maker to avoid outcome or retrospective bias, or fall into the trap of what I call “understanding the Third Balkan War.” As former National Security Advisor Sandy Berger pointed out: “History is written through a rear-view mirror but it unfolds through a foggy windshield.” If the past is to be of use to policymakers, it must be exploited in a way that avoids what economists call “the curse of knowledge,” or that cognitive bias that emerges that in hindsight, the outcome of a historical event was more predictable than was likely the case. Since we know how past events have turned out, we can easily assume that the causal path that led to the event was inevitable. But most complex and difficult policy choices involve what former Secretary of State Henry Kissinger has called “51/49” decisions: In other words, it is very difficult to know, a priori, whether a difficult policy choice will turn out correctly, even if in retrospect it seemed obvious. This is true for good policies as well as bad, which an immersion in history and an understanding of the past should tell us…..

Investors are in a way historians too. They study past events and extrapolate them into the future. They also suffer from the same challenge: the outcome of past events appears abundantly clear while the future is murky and obscure. Most investments are “51/49 Decisions”, hopefully with better probabilities, but still uncertain outcomes.

As with leaders of state, we face an uncertain future. Most important is often broad-based policy, or strategy, rather than specific actions. To use a farming analogy: investors need to till and feed the soil, creating fertile ground to sow seeds and wait for opportunities to grow. All the while exercising discipline to eliminate weeds and pests before they can spread and hurt your portfolio.

Source: Thinking Historically: A Guide for Strategy and Statecraft

I’m beginning to sound like Chauncey Gardiner, the slow-witted gardener played by Peter Sellers in the 1979 motion picture Being There (1979), who through a case of mistaken identity becomes a close advisor to the US president.

From Bob Doll at Nuveen:

….we think it is more likely than not that Hillary Clinton will be elected president. Regardless of voters’ opinions, Clinton’s policies would be more predictable than those of Donald Trump, and if there is one thing that financial markets like, it is predictability. If we are wrong in our forecast, and Donald Trump does win the election, we expect additional volatility and a likely sell-off in risk assets. In this case, we would maintain positions in equities and other risk assets until there is greater clarity about Trump’s policies.

Secondly, and more importantly, we expect markets will again focus on fundamentals after the election. And fundamentals point to an environment that should be conducive to better performance for risk assets….

The market seems to be betting on a Clinton win, judging from today’s rally, but this is still a close race.

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Nothing to do with investment, but I find these rags-to-riches stories inspiring. They are also the best refutation of Thomas Piketty’s theory*:

Not every billionaire was born with a silver spoon in their mouth. In fact, many came from nothing at all.

The “rags-to-riches” trope may be a cliché, but it’s one that’s definitely grounded in reality. Through extraordinary grit and perseverance, individuals across the globe have beaten the odds and achieved their own rags-to-riches stories.

Here are 19 people who started off life poor and went on to become billionaires.

Starbucks’ Howard Schultz, now worth $US2.9 billion ($3.8 billion), grew up in a housing complex for the poor.

In an interview with the Mirror, Schultz says: “Growing up I always felt like I was living on the other side of the tracks. “I knew the people on the other side had more resources, more money, happier families. And for some reason, I don’t know why or how, I wanted to climb over that fence…..”

Source: 19 billionaires who used to be dirt poor

* In his 2013 book, Capital in the Twenty-First Century, French economist Thomas Piketty suggests that concentration of wealth grows when the rate of return on capital (r) is greater than the rate of economic growth (g) over the long term. His “silver spoon” theory, that the primary cause of inequality is the high rate of return earned on inherited capital, doesn’t seem to fit with the high number of rags-to-riches stories in the Forbes List.

Some concentration of wealth is due to inherited fortunes, like the Walton and Mars families, but many of these are only second or third generation. Far more are first-generation wealth like Bill Gates, Jeff Bezos and George Soros.

Will Durant (The Story of Philosophy) has a far simpler explanation:

“Nature smiles at the union of freedom and equality in our utopias. For freedom and equality are sworn and everlasting enemies, and when one prevails the other dies.”

While I believe inequality is a necessary price to pay for freedom, we need to ensure that the wealthy do not exert undue influence over the political system. Else inequality can get out of hand and lead to the collapse of freedom, either by dictatorship or a populist revolt.