Are we there yet? Does reckless lead to wreckage, or recovery?

THIS INSIGHT ESSAY

This paper is written with the aim of articulating where markets might be headed in the pre- and post-Christmas period and into early calendar 2013. The contemporary and simple truth is that none of us know what is really going on and the commentary has entered the speculative zone.

At such a time, and they have occurred before, primary fundamentalists like ourselves have to resort to technical and quant analysis. What is the market telling us? In short, the market is telling us to be careful. Also at such a time we are compelled to visit our rules. The Ecinya Market Rules and 3 others are contained in our section ‘Market Wisdom’.

Our hunch is that a correction in major index terms of around 10% is imminent and it could go further IF Kevin Armstrong is correct, as he is anticipating something more dire than we are. According to one of the Zurich axioms: "A hunch can be trusted if it can be explained". John Maynard Keynes thought that it was not uncommon to hit on a valid conclusion before finding a logical path to it. We know from past experience that all information is ambiguous, but we can still function, albeit uncomfortably, in a sea of uncertainty. However, the aim at such times is to articulate the uncertainties that can be recognised and then see how they play out.

Economics has moved from the ‘dismal science’ to the ‘fragile science’ and markets are being driven by recklessly experimental central bankers rather than corporate and fiscal fundamentals. Fiscal and monetary policy are natural dance partners, but only monetary policy is on the dance floor. Can Obama re-invent himself? Is Romney/ Ryan the answer? There are a lot of balls in the air and ONE BIG BUBBLE……. the Fed’s and the European Central Bank’s respective balance sheets. Can the people who were asleep at the epicentre of the chaos find a way out, or are there sufficient personnel changes occurring, or in prospect, to herald new beginnings?

We know that genuine investors at both the retail and institutional level are confused. We know that market turnovers are relatively light. In relation to our oft used acronym ‘ICE’ (Interest rates/Confidence/Earnings), we know that interest rates need to fall in Australia, are historically low in America, are volatile in Europe. We know that confidence is low in most parts of the world as job insecurity is high, income growth low, unemployment is high, American GDP is lacklustre at best, Europe is in recession, Asia is slowing. We know that corporate earnings are being driven more by cost cutting than sales growth.

Are we there yet? Does reckless lead to wreckage or recovery?

Reckless governments, reckless commercial and investment bankers have now been replaced by reckless central bankers with the grand-daddy of them all in the third incarnation of its Bernanke-led QEs – Quantitative Easing. The first two QEs have not had any discernible impact on the real economy. There are two economies – the real economy: the production of goods and services; and the symbol economy: money and credit. The symbol economy is the tail that has wagged the real economy dog for far too long. Governments have abandoned viable fiscal policy out of fear of not being re-elected. Central bankers, acting as quasi politicians, have ushered in an era of speculative hedge funds and myopic and or quasi- fraudulent investment bankers (Goldman Sachs being the most dominant and prominent) and the result is mispricing and malinvestment. The Fed balance sheet may be a ‘bubble’.

"Are we there yet?" is the statement that impatient children make on their way to an adventure or holiday destination. In market terms ‘Are we there yet?’….. our answer is NO on a risk adjusted basis.

"Does reckless lead to wreckage or recovery?" Our answer is that it leads to recovery, but we might (and probably will) have at least one more bout of wreckage along the way. Progress, recovery will not be linear; sustainable outcomes always require reversion to the mean!

DIVERGENCE …… Kevin Armstong regards Ecinya as being far too optimistic at this point in time. Refer to –

FORECASTS, PROJECTIONS, OPINIONS, WISHFUL THINKING, MERE GUESSTIMATES – our current listing

Economists

Economists are slowly and deliberately winding back their estimates for world growth in calendar 2013 and 2014 (Westpac and other forecasts)
Economists adjust their final positions slowly to avoid admitting the recurring error of their models and a desire to not deviate too sharply from the positive spin of upper management (Ecinya and Armstrong opinion)
A world recovery needs a refreshed and re-vitalised America. Asia cannot carry a world recovery especially in per capita terms (Well held Ecinya opinion)
The IMF calling a world recession would be a sign of a significant bottoming as this organisation is woolly in prospect and retrospectively wrong in a timing sense (Ecinya opinion, the IMF is a contrary indicator)

Australia

Australia needs a federal election a soon as possible (Ecinya opinion though widely shared)
Ms Gillard is our worst post-war Prime Minister and Mr Swan our worst post-war Treasurer (Ecinya opinion)
Public debt is a big problem getting worse exponentially (Forecast by David Murray ex Commonwealth Bank and ex Future Fund Chairman)
Messrs Abbott, Hockey, Bishop and Pyne are a weak front bench making the Libs vulnerable to electoral defeat (Ecinya opinion recognised early by Editor’s spouse and confirmed in recent opinion polls)
Turnbull would make a viable Treasury spokesman provided he agreed with Abbott that the carbon tax and the MRRT had to go and an emissions trading scheme makes no economic sense (Ecinya opinion)
Australia needs a genuine reform programme in industrial relations and Joe Hockey would be a good Industrial Relations minister (wishful thinking and Ecinya opinion)
The NBN, the Gonski report, and the National Disability Scheme are unaffordable nonsense under an inept government and given the inherited problems of NSW, Victoria and Queensland (Forecasts and opinion)
The Asian Century White Paper is a monumental con job (Ecinya and others opinion)
Proper tax reform including the GST taxing food and changes to capital gains taxes and removal of many state taxes such as payroll tax would re-define the role of government in Australia and lead to a sustainable economic recovery and growth (Ecinya opinion)

America

American economic statistics are showing signs of improvement (Ecinya data base)
Obama has been an unfortunate failure as an economic manager and a victim of his own lack of fiscal experience (Ecinya opinion)
His predecessor, George W. Bush, was an even worse economic manager (Ecinya opinion but shared by notable observers including Paul O’Neill who Bush sacked as his first Treasury Secretary)
America needs a manager not another messiah, and Mitt Romney and Paul Ryan are the only potentially viable alternative product on offer (wishful thinking as it relates to ‘viable’)
Obama looks like the experiment that Jimmy Carter was after Richard Nixon lost the trust of the American people (Ecinya opinion)
IF Romney and Ryan win, the US market and markets generally will have a wishful thinking Christmas rally that may run into the early part of 2013 (Ecinya forecast, opinion and guesstimate)
If Obama wins he will have to quickly refresh his economic team and move from homilies and folksy platitudes to truth and policy (Ecinya opinion)
A sustainable bull market could start around SP500 in the range 1250 to 1350 on current reckonings in late March or April 2013 (Ecinya quant and technical analysis plus wishful thinking plus guesstimates)
America’s woes are entrenched, systemic and structural, attitudinal and psychological, and will not be cured by daily rhetoric about American exceptionalism. A back to basics approach is required (Ecinya opinion)

Europe

Europe is a basket case except for Germany – and some of the smaller cohesive nations – and something dramatic will happen in the new year (Westpac forecasts, Ecinya guesstimates and opinion)

Asia/ Middle East

The Middle East is a significant problem with no signs emerging of stability or progress (statement of the bleeding obvious)
China is a bigger worry than yet realised and unfolding political tensions and corruption allegations are a big problem (Opinion and forecasts starting to be widely reported)
China needs to change the name of the Chinese Communist Party to something like ‘The China Central People’s Party’ (Ecinya opinion)
India is slowing down (Westpac forecasts)

Comment on some of the above – imported commentary in italics

A test of SP500 around 1500 considered a pre Christmas possibility.

The Bo Xilai saga and the new revelations of the Wen Jibao $2.7billion of hidden riches is a big negative story. In The Sydney Morning Herald of 30 October 2012 it is reported under the head-note ‘China’s factions in struggle for power’ that China’s imminent leadership transition is descending into chaos, say some analysts, amid rolling scandals and signs of factional infighting between the current President and his predecessor. As Communist Party leaders converge on Beijing for a fortnight of crucial meetings centred around the 18th Pert Congress which starts on November 8, party insiders say fresh infighting has erupted over the future of the rising star Li Yuanchao. When Ecinya visited China in 2005 a prominent executive said "George, you must understand in China we have no small problems, only big ones." Editor asked ‘What is the biggest problem?" His response : "Corruption."

The word ‘Communist’ is a major impediment to improving relations with the west, and a change would signal that the 35 year resurgence of China was ready to take on a new impetus and more mature direction.

THE Gillard government white paper on Asia is a fraud. On every level, it is a con job. The government is having a lend of us. Its only admirable quality is its chutzpah……This pathetic and obsessive list making is a sign of a deep intellectual insecurity. It’s also a sign of government failure. Much of the paper itself, and many of Julia Gillard’s statements regarding it, are banal recitations of the obvious. By golly, Asia will have a big middle class by 2025 and that middle class will have a lot of money to spend. We hope they spend it in Australia. But beyond these windy cliches and vague generalisations, we are entitled to ask of this government: where’s the beef, Jack? The answer is, there is no beef.

Greg Sheridan The Australian 29/10/2012

Julia Gillard’s Asian Century White paper is a bizarre cocktail of the statement of the bleeding obvious, and a damning, if totally unintentional, critique of her government, its policies and its politics. Both the contradictions and content are so shallow that if it were a pool of water would pose no danger to a month-old baby lying on its belly, and is hardly surprising given the White Paper’s author – Ken Henry.

Ross Gittins The Telegraph 30/10/12

Reading the white paper called Australia in the Asian century is a very surprising and uplifting experience; it lists all these wonderful things that are going to happen to our nation by 2025…… There are 25 such wonderful points in the white paper, covering every aspect of Australian society and government, and all of them announcing some excellent thing that is going to happen, using the word "will". Isn’t it great? Why wasn’t I told all of this was going on? I mean to pull this off within 13 years, there must have been secret armies of people beavering away in Canberra on fixing our education, tax, and regulatory system for a decade already. Oh. they haven’t been? The white paper is just another wish paper? Damm.

Alan Kohler The Australian 30/12/2012.

Ecinya comment: Ms Gillard and Kevin Rudd spend an enormous amount of time and energy in the world of fantasy, hubris and outright delusional behaviour. We think it comes from the fact that having attained high office they believe their words have meaning well beyond their capacity to deliver and also spring from a fundamental misunderstanding of how business and economies work, function and create. Government is too often the province of people who have achieved little outside of the narrow sphere that is politics. Seymour Hersh described this delusional insanity in his book "Chain of Command, the road from 9/11 to Abu Ghraib" –

There are many who believe George Bush is a liar, a president who knowingly and deliberately twists facts for political gain. But lying would indicate an understanding of what is desired, what is possible, and how best to get there. A more plausible explanation is that words have no meaning for this president beyond the immediate moment, and so be believes that his mere utterance of the phrases makes them real. It is a terrifying possibility.

BACKGROUND

Much of the above are familiar themes as fundamental change occurs slowly…. some extracts from recent Ecinya Insights

Economic forecasts are being wound back fairly dramatically as practitioners have realised that they have got their 2011 forecasts wrong as Bernanke’s stimulus bounties underwrote the 2010 recovery. Take away the drip feed and the patient dies. As an example world growth according to Westpac Economics latest projections is expected to average 3.5% over calendar 2011 and 2012 compared with 4.2% just 3 months ago. The circa 1% difference is about US$700 billion in real terms. Fears of double-dip recession are expressed daily from reputable sources. America is struggling on all levels – fiscal, monetary, militarily, national identity; Europe has a banking and sovereign debt crisis, Japan is recovering from a natural disaster and years of almost zero growth, the Middle East and North Africa are at various stages of civil war. Strife abounds, which in simplistic terms means we are in the early stage of the opportunity cycle. Though there won’t be much evidence of recovery in calendar 2011, if policy makers work hard and politicians start to behave like adults and each communicate well, then the world should experience a normal recovery in the last 3 quarters of 2012. "Is austerity or reflation the pathway to economic recovery?" Our answer is – both are required, but with the weight on the reflation leg.

Ecinya: 7 October 2011 "Is austerity or reflation the pathway to economic recovery"

Today’s Comment: It turns out that we have thus far been wrong in that a normal recovery has not transpired in economic terms though in market terms calendar 2012 has provided opportunities for both investors and traders. A normal cyclical recovery should manifest itself sometime in 2013, but it would need to be driven by sound fiscal and monetary policy not yet in evidence.

Optimal outcomes demand that that ‘somewhere’ is at, or close to, where you want to go. Success hardly ever requires absolute precision and 95% of the time near enough is good enough. But keep in mind Peter Ustinov’s statement – ‘I love the guy who aims low and misses’.

CONCLUSIONS –

Europe can’t YET go forward.
China can’t go back.
America needs to work out where it wants to go.
Australia needs a federal election as soon as possible.

Ecinya: 13 April 2012 "All roads lead to somewhere"

In March 2007 when Premier Wen Jibao of China uttered the 4 ‘UNs’ at the National People’s Congress we assumed he was talking about the Chinese economy being ‘unbalanced, unstable, uncoordinated and unsustainable.’ Perhaps in his Confucian wisdom he was also talking about the global economy. Whatever, these 4 UNs have now permeated most of Europe and are well in evidence in the USA. and evolving in Australia. About 50% of world GDP is under threat or experiencing significant volatility. At a time of greater crisis, after the end of World War 2, led by the economic architecture promoted by Eisenhower and Churchill, the world recovered. The induced austerity of war-time shortages and putting the people to work in re-building Europe and other war-torn areas created large debt loads from the required massive infrastructure spend. Things changed because they had to as they must now. But all change is incremental and bad/ ineffective local and global leadership is not helping. A dose of truth, less innuendo and obfuscation might help.

Ecinya: 8 June 2012 "The four UNS: Unbalanced, Unstable, Uncoordinated, Unsustainable."