Macro and Markets - the importance of studying the past and making its own judgement.

"Life can only be understood backwards; but it must be lived forwards."
Søren Aabye Kierkegaard (5 May 1813 – 11 November 1855)

When approaching Macro trends as well as markets, it of the utmost importance to study what has happened in the past, in order to move forward and making its own judgement, meaning evaluating the evidence in the making of a decision with great humility.

Reading through some fantastic book: The Intelligent Investor by Benjamin Graham, Contours of the World Economy by Angus Maddison, Fooled by Randomness by Nassim Taleb, I came to a similar conclusion on different levels.
In this era of information overload, it is becoming increasingly difficult to select important information/data from noise.
By moving back and forth and studying the past with the present, it enables oneself to make better assumption of the evolution of a market or a macro situation.

As Mark Twain once said: "History doesn't repeat itself, but it does rhyme."

There are many so called experts. I do not pretend to be one. The last two years have been an eye opener in revealing the ignorance of the so-called experts in the very subject they were deemed master of. The list of the so-called experts is too long.
Some great minds foresaw the unfolding of the subrime and financial crisis. These very few, were often derided. The list is too small.

What is interesting is that many of the so-called experts who were wrong, were wrong yesterday and the day before, are still wrong today. Yet they keep voicing their so-called expertise in the media.

On January 7, 1973, the New-York times featured an interview with Alan Greenspan, the future Federal Chairman urged investors to buy stocks without hesitation: "It's very rare that you can be as unqualifiedly bullish as you can now". 1973 and 1974 turned out to be some of the worst years for economic growth and the stock market since the Great Depression. From 1973 to 1974, US stocks lost 37%.

I could go on and on, about Mr Alan Greenspan expertise in creating bubble after bubble, refusing regulation and so forth, but this is not the subject of this post.

Can experts time the market any better than Alan Greenspan? No, most of the time.

As the wise Benjamin Graham told us, the intelligent investor must never forecast the future exclusively by extrapolating the past. But at least one need to study clearly the events and causes.

There have been some bold writers in the past:
To name a few:
Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market - (Oct 1999) by James K. Glassman and Kevin Hassett.
Dow 40000: Strategies for Profiting from the Greatest Bull Market in History by David Elias (Jun 1999).
DOW 40,000: The Stocks to Own to Outperform Today's Leading Benchmark by David Elias and Jeff Zabin (7 Nov 2001).

To be fair 1999 and early 2000, bull-market "baloney" was everywhere. Valuation did not count anymore, and the most dangerous sentence in the world was being used extensively: "It's different this time".

December 7, 1999:
Kevin Landis, portfolio manager of the Firsthand mutual funds on CNN Moneyline telecast about wireless telecommunication stocks being overvalued or not: "It's not mania", "Look at the outright growth, the absolute value of the growth. Its big".
January 18, 2000:
Robert Froelich, chief investment strategist at the Kemper Funds commented in the Wall Street Journal, "It's a new world order. We see people discard all the right companies with all the right people with the right vision because their stock price is too high-that's the worst mistake an investor can make".
April 10, 2000:
BusinessWeek, Jeffrey M. Applegate, then chief investment strategist at Lehman Brothers asked rethorically: "Is the stock market riskier today than two years ago simply because prices are higher? The answer is no."

Dow Jones at the time of Mr Applegate's comment was at 11,187, Nasdaq index was at 4,446. By the end of 2002, Dow was at around 8,300 level and Nasdaq around 1,300.

Source, The Intelligent Investor, revised edition, Commentary on Chapter 3.

On March 10, 2000, the very day Nasdaq hit the all time high Jim Cramer wrote he had been tempted to sell Berkshire Hattaway short: "ripe for the banging".
Warren Buffet during that period was derided for not participating in the Technology Boom and Bust.

Closer to us as well, many predicted that the subprime crisis in the summer of 2007 was a blip. Many commented that the sovereign crisis which erupted violently this year was contained following the bail out of Greece and the "wonderful" results of the Banks Stress Test.

Although market timing is extremely difficult, long macro trends as highlighted by the work of Angus Maddison are easier to spot. In a previous post about long term macro views, I pointed that long historical trends can give us at least a good insight into the development of specific regions. For instance, there is an ongoing redistribution of the World trade shares, from the West to the East. This evolution is a rebalancing act, not a new trend as indicated by the work of Angus Maddison. It is more a return to the mean for Asia.

Yes, history does rhyme as Mark Twain once quoted.

As well as understanding macro trends and data, it is of the utmost importance to study history as it often rhymes.
A great example in the use of history and strategic thinking can be attributed to the US General George S. Patton. General Patton had studied in depth ancient history and battles. It made him excel at predicting strategic moves.
On the 19th of December 1944, during the German Ardennes Offensive Eisenhower asked Patton how long it would take to turn his Third Army (located in northeastern France) north to counterattack . Patton answered he could attack with three divisions within 48 hours, to the disbelief of the other generals present. Before he had gone to the meeting, however, Patton had ordered his staff to prepare three contingency plans for a northward turn with at least three divisions strength.
Eisenhower: "When can you start?"
Patton: "As soon as you're through with me".
Eisenhower: "When can you attack?"
Patton: "The morning of December 21, with three divisions".
Eisenhower: "Don't be fatuous George. If you try to go that early, you won't have all three divisions ready and you'll go picemeal. You will start on the twenty-second and I want your initial blow to be a strong one! I'd even settle for the twenty-third if it takes that long to get three divisions."
Extract from Patton, A Genius for War, Carlos d'Este, published in 1996.

Carlos D'Este comments: "Eisenhower was dead wrong: It was not Patton the boastful but Patton the student of war at his absolute best."

Patton had studied history and knew where the next German offensive would come. Patton always demonstrated an extraordinary desire for information of all kinds. Combined with his knowledge of history and military tactics, three different plans were ready when the Ardennes offensive started. He was already expecting an offensive as early as the 25th of November 1944.

Back to the subject of macro trends and history, the current European crisis has not been resolved, not with Greece, not with Ireland.

One of the authors of "This time is different" (a must read...), Kenneth S. Rogoff clearly indicates that the Euro is only at Mid-Crisis in a very good article indicated below:

http://www.project-syndicate.org/commentary/rogoff75/English


"Unfortunately, no. In fact, we are probably only at the mid-point of the crisis. To be sure, a huge, sustained burst of growth could still cure all of Europe’s debt problems – as it would anyone’s. But that halcyon scenario looks increasingly improbable. The endgame is far more likely to entail a wave of debt write-downs, similar to the one that finally wound up the Latin American debt crisis of the 1980’s."

Kenneth Rogoff brilliantly conclude this must read article by stating:

"As European policymakers seek to move from one stage of denial to another, perhaps it is time to start looking ahead more realistically. As any recovering alcoholic could tell them, the first step is admitting, with Merkel, that Europe has a problem."

I could not agree more. Following the credit binge which led to the current hangover, it is time for our European leaders to face the sobering facts and admit that they have been indeed addicted to cheap credit.
The Twelve-Step program for recovery from a credit addiction, as originally proposed by Alcoholics Anonymous (AA), involves the following:
-admitting that one cannot control one's addiction or compulsion;
-recognizing a greater power that can give strength;
-examining past errors with the help of a sponsor (experienced member);
-making amends for these errors;
-learning to live a new life with a new code of behavior;
-helping others that suffer from the same addictions or compulsions.

"Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it."
George Santayana (16 December 1863 – 26 September 1952)

Remembering Angus Maddison

Sadly after my last post relating to Angus Maddison, I discovered he had passed away on the 24th of April.

How ironic?

Please find enclosed a link to The Economist review on Angus Maddison's contribution to Macro Economy.

http://www.economist.com/business-finance/economics-focus/displaystory.cfm?story_id=16004937

In my last post I mentioned at length's Angus work from his excellent book Contours of the World Economy.
I mentioned that as per Angus view, China's growth is a simple reversion to the mean as he recently highlighted as per below's quote from the Economist article.

"Ten days before his death he was cited in a speech by Robert Zoellick, president of the World Bank, declaring the end of the “third world”. Maddison’s figures show that Asia accounted for more than half of world output for 18 of the last 20 centuries. Its growing clout in the world economy is, therefore, a “restoration” not a revolution."

Macro Economy doesn't repeat itself but does rhyme...

Long term Macro views - as per Angus Maddison

To begin with, I highly recommend reading Angus Maddison's book Contours of the World Economy, 1-2030 AD, Essays in Macro-Economic History.

In most of my previous posts, I have been focusing on the risks of a double dip recession and the outstanding structural issues faced by most of the developed countries.

In all that doom and gloom Marc Faber's style, there are some bright spots of development in the world and in this post I will try to highlight the incredible tectonic shift we have been witnessing in the World Economy.

I will focus on this post on looking at historical trends and I will try to highlight what to expect in the coming decades in relation to Macro Economic growth in the World.

Let's start first by reviewing the evolution of the share of World GDP from 1-2003 AD (percent of world total) as per Angus Maddison's book (page 381):

According to Angus Maddison, the share of the World GDP for Western Europe has dropped between 1973 to 2003 from 22.8 % to 16.5 %.
Between 1870 and 1913, Western Europe'share of Global GDP was around 30.5 % during the industrial revolution, although it was only 20.5% in 1820.

For the USA the peak share of World GDP was 1950 at 27.3 %. Since then their share of World GDP has dropped to 22.1 % in 1973 and to 20.6 % in 2003.

The interesting part is relating to the share of World GDP for China, the peak was around 1820 at 32.9% according to Angus Maddison. It dropped to 17.9% in 1870 which is explained by the industrial revolution experienced by Western Europe at the same time. In 1950 and 1973, China's share of World GDP was 4.6 %. In 2003, China's share of World GDP came back close to 1870's level at around 15.1 % of World GDP.

This it where it is becoming interesting, according to Angus Maddison's projection for 2030(page 340 in his book), you can expect the following:
Western Europe share of GDP will drop to 13% in 2030 from 19.2% in 2003.
Asia (including Japan) shares of World GDP will power ahead from 40.5 % in 2003 to 53.3% in 2030.
In 1820 Asia's share was 59.4 % with a low point of 18.6 % in 1950.

Asia will therefore become the largest driving force in world trade. China will again become the world's biggest economy by 2018 according to Angus Maddison, with USA at number two and India at number three!



Western European countries faces the following massive headwinds:
Ageing population for a start.
Very high debt to GDP ratios which will weight very severly on maximum GDP growth attainable. Given current budget deficits, private growth will be hindered by higher taxation and larger weight of the public sector on the GDP.



When the average debt to GDP in percentage will be around 100% in 2014 in Europe, Emerging markets average debt to GDP will be in the region of 35 % in 2014.



This graph comes from the following interesting research document published by Deutsche Bank which can be obtained using the link provided below:

http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000255134.pdf

The authors of this very good research document conclude with the following statement:

"Should consolidation fail, policymakers in DMs and some EMs may be tempted to look for other ways to fix the fiscal damage. Either they could tolerate a substantial acceleration in CPI inflation to inflate public debt and/or they risk severe adjustments in the real effective exchange rate. Such adverse scenarios should not be
disregarded. The assumption that major macro issues cannot go wrong in the DM world (including EMU) has to be scrapped in the aftermath of the global crisis while this time EM, not DM, economies are the ones in the lead to keep public indebtedness sustainable.
Welcome to a new world!"

Emerging markets Debt is therefore the new investment grade and Western Europe Debt looks more and more like the new High Yield (or junk already for some countries...).
While most of western developed countries are busy trying to debase their currencies to generate inflation, Asian currencies will continue to outperform due to the very good situation of their economy, enjoying both trade balance surpluses and manageable debt to GDP levels.

http://www.marketwatch.com/story/asia-currencies-outperforming-stocks-on-fund-flows-2010-04-30?reflink=MW_news_stmp

In relation to Commodities and Gold in particular, I expect them to continue to rise in the near future. As I mentioned previously in this blog, this is the reason why so many hedge fund managers are heavily exposed to Gold (Paulson, Moore, Soros, etc). This is part of their macro strategy following the ongoing rebalancing of the World Economy we are experiencing. They are simply betting that our politicians will try to inflate their way out of the debt problem we are facing.

In terms of macro investments, Asian currencies will rise against the Euro, USD and GBP. Fixed Income Emerging Markets funds will do very well in this new environment given their lower probability of defaults depending on the country they are exposed to (South Korea, Singapore, Taiwan, Maylasia, Indonesia are attractive).

According to the Deutsche Bank research, we are in a new world, I will conclude this post, that it is more a return to the mean, as Angus Maddison is clearly illustrating in his research. Asian countries are returning to the level of world GDP shares they had 200 years ago and before.

Like Mark Twain said "History doesn't repeat itself, but it does rhyme."

Same apply to Macro Economy, it doesn't repeat itself but it eventually does rhyme.

2010: Happy New Year and welcome to the New Normal

Happy New Year to all of you and welcome to the new normal economy in 2010.

In the new economy, unemployment levels are going to stay high and all the politicians are under tremendous stress of the need to cut into public spendings.

It is election year for both the UK and the US, and you can expect a lot of discussions relating to public spendings.

We can only hope that the time for complacency and misguided economic politics have come to an end.

Troubles are unfortunately still brewing in many parts of the world. It is important to track the below countries and situations.

Take Venezuela for instance, they have just announced a 50% devaluation and are facing inflation levels of around 20% and rising. They also have escalating tensions with their neighbors Colombia. Although Venezuela is highly dependent on the prices of oil, it looks like Chavez Socialist Revolution is heading towards a Zimbabwe situation.
Argentina is also facing troubles, with the president removing the president of the central bank.
Greece hasn't yet come up with a drastic plans to rebalance its books and the EU doesn't want to come to bail out Greece until they have done their homework in the first place.
In Iran, civil unrest is gathering momentum and one could expect its president to follow the same fate as Nikita Khrushchev.

But there are also some bright spots in all that doom and gloom, you can expect the BRICS countries to continue powering ahead. China has raised its rates in an attempt to control the hot money pouring into its economy. Indonesia, Vietnam, Singapore, are all growing strongly.

Everyone is talking about the power shift between the West to the East. The reality is that the world is shifting again to its equilibrium, and for those of you who have read the excellent work from Angus Maddison, Contours of the World Economy, Asia is basically claiming back its once 50% owned market share of world GDP. We are seeing a reverse to the mean.