Saturday, December 20, 2008 0 comments ++[ CLICK TO COMMENT ]++

Stephen Roach sees weak growth

One of my rules in investing is to be skeptical of economists' predictions. Economists generally don't consider valuations when making proclamations. They also tend to be influenced by peers and have a habit for looking backwards quite often. Nevertheless, since I am macro-oriented, I do think it's worth paying attention to the general picture that is put forth by an economist.

One of the economists I was influenced by in the past was Stephen Roach of Morgan Stanley. He was a bear for a long period of time. So much so that he was "promoted" and sent off to head their Asian operations. You never heard much from him after that, of course. Another bear at Morgan Stanley, Andy Xie, who I think is too extremist and is often wrong, was fired around the same time period a few years ago for claiming that a big chunk of Singapore wealth comes from the Chinese and Indonesian organized criminals, corrupt politicians, and other nefarious sources. Xie was very bearish on China and has influenced my thinking. Who knows if I'm right but I have been bearish on China for years primarily due to the thinking of these two economists. I also because bearish on commodities a few years ago due to their influence and that has mostly been a poor strategy in the last few years. Roach was one of the first ones I encountered, who was skeptical of the de-coupling theory and often remarked how a big chunk of the Chinese economy was dependent on foreign exports (I think most commodity bears, which included me, never believed in de-coupling.)

A lot of what Stephen Roach was saying a few years ago has come true. However it has taken a long time--too long to be profitable for an average investor. He was also wrong along the way, including one of his comments early this year that China may "export" stagflation. This seemed like a bizarre call from him, given that he has continuously warned for years of potential overcapacity in China, as well as overconsumption in USA. If the current state is too much production and too much consumption, when things turn sour, it was unlikely you were going to have overall inflation (although inflation in certain industries, or certain regions of the world, is always possible.) What was more likely is a decline in production and decline in consumption. This is what we are seeing right now, although I don't think too many knew that a contraction in credit would be the cause (I personally was guessing that an economic collapse in China, which results in China dumping products on the world market, would be the cause.)

Anyway, Bloomberg has a short interview with Stephen Roach and he touches on some current issues.

The Bubbly Treasuries?

Stephen Roach says that all of Asia is in recession or slowing down significantly. I think one just needs to look at the stock markets in those countries and see how investors are marking down future profit expectations. I am still bearish on emerging markets because there is a small probability of China facing some economic problems that may mutate into political problems. As world trade slows down--it will never grow like it has in the last few years--there is risk for more suffering.

When it comes to the purported Treasury bond bubble, he is not so sure that bonds are going to collapse. He doesn't seem to have a strong opinion but he pointed out that many who shorted Japanese bonds a decade ago were "washed out" in the end. I share similar sentiments as Roach. US government bonds seem like a bubble but if we enter a situation like Japan, with low growth, or continuously entering mild recessions/deflations, bonds can rise more than many imagine.

I also feel that shorting bonds is not as contrarian as it seems. From a market point of view, it is contrarian. That is, huge sums are being parked at super-low yielding Treasuries so you are going against the market. However, I feel as if the mainstream is also thinking as if bonds are a bubble. I mean, when mainstream media contemplates if Treasury bonds are a bubble, I don't feel it's very contrarian. Even some amateur bloggers (not the contrarian blogs but the momentum/trader blogs) are contemplating shorting US government bonds, I don't get too comfortable with that position. (What I would consider more of a contrarian position is something like shorting gold right now. I'm not recommending it and I haven't thought about it, but notice how very few, either the mainstream media or the bloggers, are talking about such a position.)

On TARP...

Roach prefers the original TARP plan, whereas I don't. He thinks the credit market lockup will only be solved when assets clear. He expects the government to help by purchasing assets but I have indicated in the past how that won't work too well (unless you purposely overpay for assets i.e. transfer wealth from taxpayers to shareholders and investors.) There is no way the government knows what the assets are worth. I mean, just look at how AIG's original bailout was supposed to be something like $15 billion (management claimed that was their collateral posting need) yet it has turned out into a monster plan of over a $100 billion.

I personally think the credit markets are going to take a while, maybe an year or more, to start functioning well. One flaw with a lot of the thinking is that many analysts and investors don't seem to realize how badly risk was underpriced in the last few years. I see a lot of people plotting charts of various spreads, bond yields, and so forth, in the last 5 years and pointing out how things are still very high. Well, if they take those charts back by a few decades, those yields are not high at all. For instance, I see many referring to CDS on various corporate bonds and pointing out how they are high compared to 5 years ago. Well, CDS was irrationally low 5 years ago so some of what we see may be, as shocking as it might be, normal.

USA Similar to Japan?

Roach thinks that USA is somewhat similar to Japan in the 90's. He mentions that Japan had two bubbles, real estate and stocks, and USA also had two bubbles in real estate and credit. He says both countries had weak regulatory and political management over that period. He also, ominously, says that the bust has infected a greater part of the US economy than what happened in Japan. That is, the bust in the US has hurt the consumer, which is the largest portion of the economy.

I am not as pessimistic as Roach. I think USA is much better off than Japan. Some of the reasons include a more free market economy, stronger corporate balance sheets, better demographics, and more diversified economy. Nevertheless, the US economy will not grow like it did in the 80's and 90's, and asset markets, particularly real estate and stocks, are unlikely to do as well as the in 90's.

Likes Infrastructure Spending

Roach likes the infrastructure plan of the Obama administration. He thinks US consumption is way too high, something like 72% of world GDP growth(?), and needs to come down. The re-balancing that Roach has been talking about for years is finally occuring. But I'm not sure how efficient the infrastructure capital programs will be.

I'm not an American so it's not my taxes at risk but I'm still not too sure about the Obama administration infrastructure spending plan. The problem is that it is a desperate move to do something, anything, before it's too late. Given how many states and municipalities are cash-strapped, I wonder if anyone can afford to maintain any newly-built infrastructure.

I'm pretty sure that a lot of the spending is going to go into some lame project with questionable long-term benefit. Ideally, it would be better if they spent the money on a long-term plan. For instance, it would be better to spend billions building a few nuclear reactors since it is almost certain that energy use would be higher in 20 years than now. But these projects take too long to plan, and could take years for workers to re-train, so the government is looking for a quick stimulus.

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