Tags: Japan | China | growth | investors

Complacency Remains a Dangerous Attitude in Today's Investment Environment

Tuesday, 06 Aug 2013 09:29 AM

By Hans Parisis

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Lately, we've heard some noise about early signs of rising, albeit cautious, optimism on renewed early signs of global growth.

The JPMorgan Global Manufacturing & Services Purchasing Managers' Index (PMI), which is an index produced by JPMorgan and Markit in association with the Institute for Supply Management (ISM) and the International Federation of Purchasing and Supply Management (IFPSM), was at its best level in 16 months, coming in at 54.1 in July against 51.2 in June, nicely above the 50 extension-contraction watershed.

In my opinion, long-term investors would do well not getting too excited because of the apparently hopeful "face value" of the index, because when we take a closer look at the details, the better performance was mainly achieved thanks to stronger growth in the United States and the United Kingdom, where "all-industry" PMIs performed about 10 points better than the average numbers of all other "big" global players together. This underlines the remarkable "uneven" economical performances among all big economical blocs in the world.

Maybe it's also wise not to overlook the fact that in the all-industry PMIs, Japan slowed to a five-month low in July, while China, Brazil, India and Russia all showed contractions.

Long-term investors should keep a very close eye on how emerging market debt behaves further down the road, because it could easily become, in the foreseeable future, the same kind (or even worse) of catalyst, as was the sub-prime debt in 2007 that caused the crisis that followed.

While it's still way too early to consider this as a blinking warning signal, I don't think would hurt to put "cost" inflation back on your radar screen, as the latest numbers show it re-accelerated to a five-month high in July, although it is nevertheless remaining relatively weak.

Once again, I wouldn't be surprised to see different paths developing of cost inflation between developed and developing economies.

Tuesday, the latest HSBC Emerging Markets Index, which is derived from the monthly PMI surveys, revealed an uncomfortable "overall contraction" in output. The figure came in at 49.4 in July, down from 50.6 in June and dipping for the first time since April 2009 below the 50 mark. The composite PMI indexes for the individual emerging economies were all in contraction territory in July. Specifically, China came in 49.5 in July, compared with 49.8 in June, while Brazil was 49.6 versus 51.1, India was 48.4 versus 50.9 and Russia was 48.7 compared with 50.1. Global emerging markets' employment remained practically unchanged.

It now should become crystal clear to all remaining short-term optimists on China that the country's growth engine has finally slowed down to such a level that providing further growth expansion stimuli to not only all other important emerging economies, but also to developed economies, is no longer on the table for the foreseeable future.

In my opinion, long-term investors should become extremely cautious about their expectations on Chinese growth and substantially scale down, while there's still time, all direct and indirect investments in the country.

To me, it will be extremely, if not completely impossible, for China to escape a hard landing scenario sometime in 2014.

Of course, it remains to be seen and only time will tell if a Chinese hard landing would finally cause a full broad-based crash, but which wouldn't surprise me at all.

The reason for this is relatively simple — this time around China won't be permitted at all, primarily for internal political/social-related reasons, to abruptly expand once again its money printing by about 30 percent, as it did in 2010.

Today, such a size of extra money printing would undoubtedly cause a sharp rise of inflation, which, in turn, would imply the risk of emerging social unrest all over the country. That risk by itself should prevent authorities from using the printing presses once again.

But that's unfortunately not the whole picture of the coming huge challenge that will arise when China won't be allowed to inject "internally" huge amounts of "newly created" money because the whole house of cards of China's actual economical structure, as it was engineered by the former politburo, would be at serious risk of coming down precipitously. In my opinion, there is a more than 50 percent possibility it will happen anyway, but, of course, I could be wrong.

Remaining in the Far East for a moment, the International Monetary Fund (IMF) just published its "Japan 2013 Article IV Consultation" country report. In the "Staff Appraisal" under point 47 it states interestingly: "The absence of credible fiscal and structural reforms could weigh on confidence and undermine the success of the started reforms. This would not only be detrimental to Japan, but also for the rest of the world, especially emerging Asia. … As Japan's debt would remain unsustainable, a global tail risk of a spike in yields and volatile capital flows would remain on the table."

It's evident the IMF did not take into account the dire consequences of the Japanese fiscal reform experience of 1997 when Prime Minister Ryutaro Hashimoto, among other things, implemented a 2 percent increase to only 5 percent of the national consumption tax. This tax, which should be raised by April 2014, was blamed in part for Japan falling into a recession shortly after the tax hike implementation.

Let's hope this time will be different and "Abenomics" won't stumble over the same kind of fiscal reform stone, because the fat tail risk of such a mishap could easily bring the economic world as we know it today down to its knees, making the latest global crisis, in comparison, only look like child's play.

Finally, the economy in the eurozone is starting to show less worse signs than we got used to as of late. Let's hope it's not one of those false dawns. It's good to take notice Italy, the fourth economy in size of the European Union after Germany, France and the United Kingdom, announced its economy continued in is its longest recession since World War II. For the eighth consecutive quarter, gross domestic product was negative, with the second quarter of this year -2 percent year-over-year.

From my side, I still remain cautious about Europe, because nobody really knows how many skeletons are still left in the European closet. As long as the eurozone can't find a doable solution to re-adjust its initially wrongly and irrevocably "fixed" internal exchange rates to the euro, I can't see better times ahead.

Finally, U.S. markets are so far continuing to treat good news as good and bad news as even better. The United States remains my preferred location in a still "bad" global neighborhood.

Besides, I also continue to expect the U.S. dollar as one the better safe haven currencies in 2014. What comes thereafter is anybody's guess.

Yes, there are still a lot of wheels that could lose control in various important developing, as well as developed markets, all over the globe. One thing is for sure, it will be a bumpy road — no doubt about that — and unpleasant sudden surprises are definitely on the menu.

In my opinion, complacency remains a dangerous attitude in today's investment environment.

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