Storm clouds over the global banking village [CPI Financial]
(CPI Financial Via Acquire Media NewsEdge) The trauma of the 2008-9 financial crisis culminated in the failure of Lehman Brothers, global recession, currency wars, Occupy Wall Street, the European sovereign debt crisis and unorthodox central bank policies that have led, as Keynes once predicted, to the euthanasia of creditors. In retrospect, it is not difficult to pinpoint the myriad forces that led global finance to the brink of systemic failure in 2008. These ranged from post Glass Steagall's excessive deregulation, the Greenspan Fed's recurrent tolerance of asset bubbles, the malign ostensibly innovative, Frankensteins in the credit markets (CDO squared, shadow banking SPV's), the political power of megabank CEO's in Capitol Hill, Westminster (as well as Reich Chancellery, the Elysee Palace and the Kremlin!), securitization gone berserk in Wall Street and the City of London, the borrowing binges in Club Med and frenzied property speculation.
Five years on, the ultimate structural flaw lies in the current global system itself. This is an updated version of the Triffin paradox in monetary economics. Triffen predicted that the Bretton Woods gold-dollar link was doomed to failure as LBJ's refusal to raise US taxes to finance the Vietnam war and Great Society in the 1960's would saddle Europe with excessive dollars, that the system was designed to self destruct. As it did under Nixon. The US trade deficit is the world's most colossal dollar supply engine in the hyperkinetic, networked daisy chains of leverage in 2013's global money markets.
Since Uncle Sam is the world's lender/spender of the last resort, the Fed can (and does) engage in the deliberate devaluation of the US dollar. After all, "In Bernanke we trust" is the unwritten motto of dozens of global central banks and countless investors who now hold more than $10 trillion in US dollars reserves under a flawed system that allowed the Federal Reserve to devalue their wealth by two thirds since 1987 alone, the year President Reagan appointed Greenspan as the high priest of history's most epic Ponzi scheme. Ask your banker to give you a twelve year chart of the US Dollar Index (DXY) from Bloomberg. It will horrify you.
Ever since the Asian financial crisis in 1997 and the oil crash of 1999, central banks in the Pacific Rim, Russia and the Arabian Gulf have amassed $6 trillion in dollars to hedge against the risks of banking crises or global commodity bear markets. This reserve creation was amplified by China's export led development model that grossly undervalued the renminbi and enabled the accumulation of $2 trillion in Uncle Sam IOU's, history's biggest vendor financing program. The tenfold rise in Brent crude in the past decade amid geopolitical risks in the Middle East led to epic reserve accumulation in Russia and the OPEC states, with even Nigeria, Gabon, Angola and Libya boasting sovereign wealth funds. Is Congo next
This enabled the US to go on a consumer credit binge amid a real estate/banking bubble consciously inflated by the Fed. This was the reason I predicted "the coming global financial crash" in a column in January 1, 2008, admittedly prematurely. Long term US Treasury bond rates have now plunged to 50 year lows and enabled Washington to accumulate a $16 trillion Federal debt bubble. Now the Treasury bond chickens have come home to roost.
The US Treasury is the most dangerous planetary bank as it recycles the world's savings into risky assets that pay negative real interest rates. This is financial repression and its endgame will end in monetary crises and collapse in confidence on the dollar, as Triffin's paradox did when Nixon closed the Fort Knox gold window. Santayana was right. Those who refuse to learn the lessons of history are doomed to repeat them. Especially in the bond market.
Macro Ideas - The quest for Alpha in Asian shares
The spectacular rallies in Japan, China and South Korea since their recent political transition have only reinforced my enthusiasm for Asian shares in 2013. After all, Goldilocks is alive and kicking in the Pacific Rim, the global economy's high growth/benign inflation (for now) epicentre. Of course, high GDP growth alone is neither a necessary nor sufficient reason to own equities in EM, as China proved in the past half decade. So I dissect Asian macroeconomics, FX policies, debt markets, sovereign risk metrics, fund flows, policy peculiarities and industrial constellations for asymmetric risk/reward ideas that make money.
Last year was good for my Asian equities calls. There were spectacular money making opportunities in Singapore industrial REIT's, Thai banks, Philippines sovereign debt, South Korean financial conglomerates and Hong Kong property developers that I communicated to my readers and friends (everywhere from Wall Street and all points east of Suez!) last year.
South Korea at 9 times earnings in my idea of valuation nirvana with now a pro-chaebol President (Madame Park) in Seoul's Blue House, all quiet on the DMZ/Pyongyang front and a massive cyclical delta in Chinese, Japanese and ASEAN growth. It did not surprise me at all that the South Korean won was the best Asian currency to hedge dollar assets in 2012, up almost 8%. I spent my twenties eating kimchi in Manhattan's Koreatown discussing the economic miracle on the Han River with South Korean colleagues at JP Morgan Chase. The payoff As fascination with the corporate icons of the KOSPI and KASDAQ that I hope will make money next year.
Dragonomics is another theme that I expect will be profitable next year, though the China bull market is dependent on both policy reform and PBOC easing as well as no US recession, Euro shocks, Politburo/CPC public power struggles or global oil spirals. The empire of the rising Nikkei Dow and sinking yen This is the most spectacular macro trade in the world but it was not when I was begging my friends in town to sell yen against Mexican pesos and buy Nikkei exporters/banks, a 25% annualized dollar trade The Japanese stock market, led by Komatsu, Nomura, Tokio Marine and Fire, Mitsui Fudosan, Hitachi and Fujitsu, has once again become my intellectual obsession for 2013. Where else in the world can I buy 20% earnings growth in a market priced at book value, albeit with 8% ROE and a 13 times multiple. Dai Nippon banzai!
Which market would I diss/short next year in Asia Malaysia, since political risk of a Anwar Ibrahim political upset is simply not priced into the KLCI or ringgit. Unlike my hedge fund friends in London and the East Coast, I believe the Philippine banks/property/consumer stocks are now priced to perfection, as are most Singapore REITs and Hong Kong property developers that in 2012 offered credible 20 – 30% upside. I would gladly reenter Thailand's SET index but only on a correction down to 1250 – 80, which is not unlikely given the political chasm between the Shinwatra clan Red Shirts and its elite Bangkok/military/deep state "Yellow Shirt" opponents.
I admit Dalal Street and Sensex/NIFTY is my biggest enigma for 2013. Inflation peaks, RBI cuts and reform momentum could goose the Sensex to 21,000 as forward valuations are not expensive. In Singapore, I want to see Straits Times below 3000 to buy DBS and Capital Mall.
Indonesia is a full standard deviation above historic ranges, the rupiah is iffy, the Yudhoyono era is in its twilight and the Bumi/Nat/Bakrie fiasco brings back awful memories of 1997 governance abuses. For me, 2013 is not the year of living dangerously in Jakarta. Alpha rocks, but beta hurts!
Currencies – The Euro and gold trades were winners!
My recommendation to sell Euro at 1.32 and gold last week were both profitable. The US dollar continues to devalue against the world's major currencies (apart from the yen), with the Mexican peso the biggest winner against the US's sixteen largest trading partners. My bullishness on the Mexican peso at 14 in last June minted money now that the peso (symbol MXN on Bloomberg) is now 12.75. To add insult to injury to greenback holders, the Mexican peso offered and continues to offer 4% in carry (higher interest income). It is ironic that the US dollar plummeted in 2012 despite a manufacturing renaissance, a housing revival, a shale oil boom, a spike in vehicle sales, a fiscal cliff deal and a bull run on Wall Street. The culprit The Bernanke Fed's money printing spree, that will add another trillion dollars to the central bank's balance sheet in the next twelve months even as Europe's systemic risk declines.
What monetary catalyst could arrest the decline of the Sad Sack dollar A monetary policy U-turn by Uncle Ben, credible tax/entitlement reform, an unexpected geopolitical shock or a banking disaster somewhere in the world's dark alleys. This scenario is now not all as priced in as the Global FX Volatility Index is now at 7, its level in the 2007 pre-Lehman Stone Age. Risk has never been so mispriced in the FX market as private bankers happily suggest short gamma Euro trades to me.
Eurodollar futures on the Chicago Merc do not price a Fed rate hike until August 2015. Yet if US economic growth begins to accelerate, the Bernanke Fed could well be forced to abandon its open ended, dual mandate pledge to buy $85 billion in US dollars and MBS. Any hint of a policy shift in the FOMC would cause US Treasury debt yields to spike, dollar yen to rise to 100 and the Euro to fall below 1.30, particularly if the ECB is forced to cut rates on a German recession and Spain/Catalonia hesitates on a OMT bailout.
My basic contention is the Big Four central banks will continue to operate their galactic/cosmic QE liquidity pump. This means Aussie/yen and Euro/yen are the default barometers of risk assets while carry will continue to boost non intervention EM currencies like the South Korean won, Mexican peso – and even dirty float regimes like the Indian rupee and the Russian rouble. The politics of safe haven currencies have witnessed a seismic shift. Abenomics makes the yen leprosy. The SNB floor takes out the Swiss franc. The US dollar, while a beneficiary of Lord Keynes's seignorage and the world's biggest debt capital markets, is constrained by the Bernanke Fed. AAA rated petrocurrencies were my anti dollar hedges in 2012.
This led me to the Norwegian kroner, Russian rouble and the Canadian dollar, though the easy money has now been made. My call The year of the Snake will be most kind to deep value, deep distrust, deep political risk, high carry currencies. In my opinion, the land of the pampas, tango, Maradonna, gauchos and my twin heroes Mario Kempes and Jefe-Caudillo Alejandro Allende. I believe the Argentine peso could well offer prescient UAE investors a 15% total return in dollars in 2013. But Argentina is, well, Argentina. The most overvalued currencies in Europe The Swiss franc and the Czech Kroner, where a 7 – 8% fall is all too possible.
I was enchanted by the fairy tale beauty of Prague on my last visit but dismayed by the economy of the Czech Republic. It is now obvious that CNB policy is to engineer a depreciation as recession looms (46 PMI). The Czechs are Mitteleuropa's Singapore, with 78% exports to GDP headed to a Europe in recession. Real bad news in Bohemia!
Stock Pick – The bullish case for IBM
Big Blue is on a roll. While 80% of IBM revenues are now derived from recurrent software/services, hardware sales have fallen consistently since late 2011 and Big Blue is not immune to macroeconomic distress in Europe. So revenue growth could well decline in 2013, though new product launches, IBM's footprint in emerging markets and its evolution as a software/IT services colossus will protect operating margins and EPS growth. This is all the more true since IBM in the midst of a cost/business mix reconfiguration process on a global scale.
IBM can well deliver $17 in EPS next year and operating margins just below 20% on revenues in the $108 – 112 billion range. No other company in the world wins as many patents as IBM and its R&D budget is an incredible $6.5 billion, the reason it has gained such scale (second only to Microsoft) in software, especially in databases, middleware, business intel, management performance/SME etc.
IBM's 3Q was a bit disappointing in revenue growth and margins trends, so it does not surprise me that the shares lost $20 since their early October peak. The consensus expectation for 2013 earnings is $16.30 and I have seen IBM trade as low as 10 times earnings when revenue growth slows, so in the best of all Panglossian worlds – I would only go gaga on Big Blue again somewhere near $165. IBM's software/GBS revenues were mediocre in Brazil, Japan and Western Europe, where verticals like state/local governments slash IT budgets.
However, since IBM has the ultimate fortress balance sheet in corporate America, a history of management excellence that goes back decades to the legendary Watson clan (and James Harrington my brilliant friend and one of Big Blue's great strategy gurus), no less than $11/share in cold, hard cash (to borrow the words of the Material Girl's definition of the corporate Mr. Right) and the most defensive recurrent revenue mode in IT, IBM will emerge leaner, fitter from the latest decline in IT spending.
As Apple, Dell, Intel, Infosys, Accenture and HP woes demonstrate, Wall Street is in an unforgiving mood for even the most minor of setbacks in Big Tech. Yet IBM downside is limited by its unique, resilient, innovative, networked integrated solutions business model. As expectations for revenue growth/EPS come down, so will comps for next year, with the promise of upside surprise sizzle. The $165 downside target I expect is more or less where Big Blue traded during the September 2011 debt ceiling fiasco. After all, at least two thirds of IBM bottom line is recurrent and the Power 7 plus processor and Integrated Pure Systems product suites should definitely goose EPS in 2013, with its growing cloud computing and data analytics software businesses still in hypergrowth mode.
To reduce market risk, I believe a long IBM/short Infosys ADR pair trade could prove a money maker n 2013. Metrics such as new client wins, project revenues per professional and client retention for Infosys are all pointed in the wrong direction, even when compared with TCS, Wipro and Cognizant. In any case, Infosys has nowhere near IBM's proprietary intellectual capital, global client base, software offerings or generations old linkages to the world's preeminent corporate boardroom and, above all, R&D muscle in emerging technologies. The shift from outsourcing to consulting hits Infosys margins/EPS. It made no sense for Infosys to become Accenture at a time when Accenture consulting revenues are in the proverbial doghouse.
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