By Steve Blumenthal, CEO, CMG Capital Management Group
I highlighted three valuation measures earlier this month Click Here: one based on reported earnings through 12-31-2014, one based on operating revenue, and Warren Buffett’s favorite valuation indicator Stock Market Capitalization as a Percentage of Gross Domestic Income. The market is expensively priced. The problem is that when valuations are high, the probable forward returns are low. This doesn’t mean the U.S. equity market can’t go higher from here; but it does mean that risk is much higher.
In last month’s post, we highlighted real estate and slow growth warning signs of what seems to be an inevitable economic crash in China. The scariest part about these flashing signs is that there are plenty more indicators we hadn’t touched on. Let’s look deeper into some of the unemployment and debt issues China faces as it moves towards a tipping point of what could be an economic crisis.
- Fewer workers moving to cities: The workforce contracted in 2012 and 2013 by 3.45 million and 2.27 million workers, respectively. The Japanese bank, Nomura, states that the number of migrant workers has halved from 12.5 million to 6.3 million over the past four years.
- Debt, debt and more debt: Total bank debt has grown from $14 trillion in 2008 to $25 trillion today. This represents the equivalent of adding the entire US banking system in the past 6 years. A recent S&P report in June announced that China now has the largest corporate debt market in the world (although there are some questions regarding the validity of data). Furthermore, the Bank for International Settlements, has indicated in its recent annual report that China’s financial system is “flashing red” as private sector debt to GDP is 23% higher than its long run norm.
“I hear and I forget. I see and I remember. I do and I understand” – Confucius
Confucius was full of wisdom. The ancient Chinese philosopher and scholar continues to impact society today with his aphorisms and proverbs, the most famous of which is the “Golden Rule” which most of us learned as children (his version read “Never impose on others what you would not choose for yourself.”)
The quote above reflects man’s inability to learn from hearing or seeing – only by experiencing an event, does man understand. This teaching is particularly relevant to financial markets: business cycles, debt cycles, financial crisis, economic policies and investor behavior. Despite a wealth of financial history at our fingertips, in aggregate, investors tend to repeat the same mistakes over and over again, always thinking “this time is different”.
“I’m turning Japanese, I think I’m turning Japanese, I really think so.”
The English band, the Vapors, was an 80s one hit wonder with the song “Turning Japanese.” I was never a fan but the tune seems to be getting renewed airplay with a very narrow audience these days: central bankers and economic policy makers. The song has little to do with Japan, or Asia for that matter, aside from a clever oriental riff (it’s actually about love). That hasn’t stopped policy makers from taking the chorus line at face value: namely the risk of their economy “turning Japanese”.
Turning Japanese in today’s macroeconomic environment means that your country (or block of countries) is at risk of deflation and if action is not taken quickly and decisively, that risk can turn into a 20 year battle, just like in Japan.
The world’s fascination with Thomas Piketty and his book Capital in the Twenty-First Century is not abating. In the Bloomberg TV video today, Piketty Says FT Made a Fool of Itself Over His Book (video embedded below), we see that the “analysis” by the FT and Piketty’s aggressive response keeps this story cycle spinning and book sales moving along briskly. This is probably the most popular economics book in generations and perhaps the most popular book of any genre now, according to the Bloomberg Anchor. As they say in Hollywood, this story has legs.
Where do I stand on the Piketty debate? I agree with this assessment by Peter Schiff: “There can be little doubt that Thomas Piketty’s new book, Capital in the 21st Century, has struck a nerve globally. What is surprising, however, is that the absurd ideas contained in the book could captivate so many supposedly intelligent people.” If you want a thorough analysis, read Peter’s excellent article in Advisor Perspectives: Piketty’s Envy Problem.
È tempo per un po ’di QE? Nein danke. Vielleicht?
TRANSLATED: Is it time for a little QE? No thank you. Maybe?
Although Mario Draghi, President of the European Central Bank (ECB), announced that the Bank’s governing council is prepared to take emergency action if inflation falls too low, it may be a case of too little, too late. By emergency action, he of course means quantitative easing, which to this point has been anathema to German policy makers.
Each of the EU’s competitors has acted with some form of stimulus, loose monetary policy or unconventional quantitative easing in an attempt to stimulate growth. In the U.S. we have gone through every monetary tool in the bag. In the UK, the Bank of England is so pleased with its QE, it is considering whether it needs to make “any adjustments” (read “any” as in “any, ever”) at all to its bond buying programs.
Before the recent events in the Black Sea, few investors, financiers or market commentators would have been able to place Crimea on a map, much less appreciate its impact on the global financial markets, investment portfolios and stock market risk. The events of the past several weeks in the Ukraine and Crimea have captured everyone’s attention as hot headed media analysts talk of a new Cold War and Putin’s annexation of Crimea. The truth is much more complicated than that and the impact of these events is much more subtle than the headline grabbing sanctions against Russian oligarchs seeking to fill their shopping bags in New York or London.
The Ukraine has been at a crossroads of east and west, Europe and Asia for hundreds of years and ethnic boundaries are rarely as easily drawn as the maps we use to find these distant lands. Elections over the past several years have worn out these historic fault lines – the east pulling towards Russia and the west aspiring to join the EU. Historically, the Russians, the Poles, the Austro-Hungarians and the Ottomans (to name a few) have battled and controlled these lands at various points in history pulling the country, its borders, its culture and religion in different directions. During the second world war (or the Great Patriotic War as the Russians and eastern Ukrainian’s refer to it), these tensions were strained further as fascist resistance to communist forces moving west made a hero out of Ukrainian Insurgent Army leader, Stepan Bandera (to western Ukrainian’s) (in 2006 a statue was erected in the central square of Lviv.) While not the majority of protesters, members of the extreme nationalist right wing who were involved in driving President Yanukovych out, draw much inspiration from Bandara’s fascism and rumors are rampant about the extent to which right wing protesters were involved in scuttling the compromise, which ultimately lead to the departure of Yanukovych and then subsequent Russian action in Crimea.
Shuli Ren, the Emerging Markets reporter for Barron’s, posed the question “How Much Weight Should Emerging Markets Have In Your Portfolio?” She spoke with Steve Blumenthal about exposure in Emerging Markets and the CMG Global Equity Strategy. The Strategy, structured with Absolute Return Partners, offers a new mutual fund CMG Global Equity (GEFAX) that uses quantitative scoring methods. This method screens companies that can generate higher Sharpe ratios
The CMG Global Equity Strategy portfolio consists of 50 equally-weighted stocks (2% each), selected at the end of May each year when companies release their annual reports. This May, from a universe of 35,000 publicly traded companies across 150 countries, about 3,600 companies met market liquidity requirements.