Tag Archives: growth

(Revised) China’s Stimulus Package for Growth

In the past few months, the market focus has been on the Federal Reserve’s exit strategy and the slowdown of China’s economic growth. Regarding the latter one, the world-second largest economy grew at 7.4% in the first quarter, a level significantly below the double-digit growth many years ago and the 7.7% growth last year.

Since the country has set a target of 7.5% economic expansion for 2014, the below-expectation performance triggered further concern about its growth momentum. In response to that, China’s State Council, the government’s executive body, unveiled a stimulus package in early April to boost growth, including additional spending on railways, upgraded housing for low-income households, and tax relief for small businesses.

Although the package is considered as a mini one compared to the four trillion yuan ($650 billion) program rolled out in late 2008 amid the global financial crisis, it would still impact its overall economy in many ways.

Stimulus 1: Additional Spending on Railways

The government would further develop infrastructure through accelerated railway construction, particularly in the nation’s central and western regions, and more aggressive financing. Some operations in the public interest would be subsidized and 150 billion yuan ($24.6 billion) in bonds would be offered by the government to finance construction for the railways. Relatively, the stock prices of companies in the railway sector rallied, as shares of China Railway Group surged 5.1% and China Railway Construction Corporation’s shares jumped 7.2%.

Personally, I think the spending will have a double-sided effect. Positively, tremendous infrastructure construction will boost growth effectively, and the emphasis on development in the central and western region will lead to more balanced economic landscape across the country. Negatively, as China is undergoing a significant transition from being overly dependent on investments and exports to relying more on domestic consumption, the massive government-led investment project might impede structural reform, and the increasing credit along with financing might pose additional risk in the credit market.

Stimulus 2: Upgraded Housing for Low-Income Households

The government would also spend more on slum clearance and upgrade of poorer urban areas. It added that the China Development Bank, a lender for key government policy projects, would set up a special arm to issue bonds to support new homes.

In my view, this measure could be a complement to the railway construction because of its focus on ordinary people’s well-being. It is a tradition that Chinese people care a lot about their housing and treat it as one of the most important measures of their living standard. If the housing upgrade can be implemented effectively, it could ease social instability and stimulate domestic consumption in the mid- to long-run.

Stimulus 3: Tax Relief for Small Businesses

The government would extend existing tax breaks to small businesses until the end of 2016 and raise the threshold for taxing smaller businesses, which have been struggling as economic growth slows.

I do believe that small businesses will benefit from decreasing tax burden, but this measure might not address their problem radically, which is largely due to the lack of financing. State-owned banks mainly offer loans to large, state-owned enterprises, putting small and medium businesses in a significant disadvantage in market competition. So in addition to regulating state-owned banks, the incorporation of private capital for lending and in-depth financial reform is also indispensable.

In conclusion, as the market force is set to play a fundamental role in the overall economy, it is the quality rather than the quantity of growth that should be strengthened. Therefore, the new leadership should be committed to structural reform with emphasis on wealth increases of ordinary people so as to unleash domestic consumption and underpin growth stability.

The Essence of Wealth Management

Wealth management is a lifelong task. Either you are an individual investor or a professional asset manager, the central goal is to steadily increase your wealth through proper management of capital. Personally, I think there are two keys to successful wealth management: diversification and customization.

Diversification for Capital Growth

Every single investor has to face a certain level of risk when investing in the capital markets, ranging from bonds and equities to derivatives. Diversification can be effective in optimizing the risk-return payoff through well-structured asset allocation. Simply speaking, investing in asset classes with alike market performance could lead to huge reward, or huge loss as well. Comparatively, the exposure to diverse assets with different or even opposite performance is therefore a great hedging strategy, leading to stable investment return in the mid- to long-run.

Customization for the Best Allocation

After knowing the importance of diversification, we still have to face a quantitative issue of “what is the percentage of each asset class in a diversified portfolio?”, which has to do with customization.

As said in the book “A Random Walk Down Wall Street”, the risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income. Your earning ability outside your investments, and thus your capacity for risk, is usually related to your age.

Therefore, there is not a “best” portfolio for everyone. A responsible asset manager has to develop the investment decision for a particular client based on the well-rounded mastery of his/her financial situation and beyond.

Personally, I interned at AIA Hong Kong office as a financial planner last summer. One of the tasks I accomplished was “financial health check interview”. The goal of the interview was to understand the financial status of clients and ensure their benefits from total protection. In the fact-finding stage of the interview, I collected financial facts, including income level, family expenses, aggregate debt, and investment style, as well as non-financial facts, including age, family status, diagnosed illnesses, smoking & drinking habits. The integration of all these facts would offer a strong fundamental for the execution of a tailor-made financial solution spanning insurance, savings, and investment.

In conclusion, a truly diversified portfolio is not the result of a random selection from various asset classes in the market. Instead, it is derived from in-depth analysis of their features and correlations, as well as the client’s earning power and risk appetite.

Peru: potential growth hindered by politics

Politics and Economics are often grouped together by those who don’t particularly interest themselves in these subjects. As Economics students, we know that they are two very different things. But we often forget the significance of their coexistence. The world is witnessing so many cases where poor governance inhibits economic growth. Countries like Venezuela, which has the potential to be a significantly wealthy country, are held back (and destroyed, in Venezuela’s case) by incompetent and corrupt governments. The result is not only slow/negative growth, but also the lack of ability to grow because those who have wealth are too afraid to invest it in their own country. In the United States, this is not even considered because the US is perhaps the best/safest place to invest in the world. Whether or not this is actually true, what matters is that it is in fact the general belief worldwide.

Peru is a country that falls into this trend, though not to the degree seen in Venezuela. I will say, for purposes of reliability, that I am Peruvian and know a lot of information first-hand (especially about people’s views). It should also be noted that Peru is a country very much divided by socio-economic status and race (though this is improving). The current president of Peru, Ollanta Humala, initially ran for president in 2006 as a supporter of Venezuela’s Hugo Chávez; he lost that election and in 2011 reinvented himself as a “pro-Brazilian social democrat.” When Humala won the election, people feared that he would turn the country into Chavez’s Venezuela or Castro’s Cuba. Like in those countries, his supporters were mostly lower-class. But to many people’s surprise, and relief, Humala “opted to stick with the free-market policies that have brought a decade of strong growth.”

Peru had been growing significantly before 2011:

perupercap

Gross domestic product per capita nearly tripled from 2000 to 2010.

And real GDP nearly doubled from 2002 to 2011:

perugdp

Peru became an important emerging market by 2009, and recognized for its steady growth. Though growth has slowed since 2009, last year the country experienced a 5.6% expansion. Peru’s main exports are copper, gold and silver. As has been discussed by other students on this blog, China’s slow-down has had many repercussions worldwide. The decreased demand for copper, is largely the cause for this slow-down in growth. As for inflation, economists have raised their inflation projection to 2.8 percent from 2.6 percent for this year and maintained their 2.5 percent estimate for 2015. As well as a 5.7% growth estimate for 2014.

So the economy in Peru is doing well. Investment is significant, but it largely from foreigners. Though Humala’s government has done decently on the economic side, people are very distrustful of the government (and not just the current one). In Peru, a common joke among citizens is to compare stupid, incompetent, or corrupt people to those in Congress. Basically, the government has little credibility and this is influencing those with the power to invest in Peru’s financial markets. With this growth, there is an immense amount of money flowing into pockets. While I was there in December, a family friend (a very wealthy one) explained to me that there are so many people with millions that don’t know where to invest them. Since they fear the government’s instability, corruption, and dishonesty, they don’t want to invest their money in the country. And, like you probably guessed, most invest in the United States; the current fad is to invest in real estate (mostly Miami).

Thus, Peru is growing steadily and is looking at a bright future. However, the political situation is still holding back potential growth. If Peruvians saw Peru’s market as a safe investment, there would be a considerable effect on the economy. But the fact that the country has a very long history of corrupt and unstable governments (my own grandfather led a military coup), makes it difficult for people’s fears to subside anytime soon. Before that can even be considered, though, there have to be major changes in the Peruvian government — and that doesn’t seem likely in the near future. Although Peruvians are discontent with the government system, they are accustomed to it.

Bank Lending Break Through?

Bank lending seems to be back in action again. Banks all around have been on a stand still waiting for loan growth to pick up. Although the winter provoked a minor drawback, loan growth is what banks need to get the ball rolling. Without these loans, banks have had to try “to bolster earnings through repeated rounds of cost cutting and reversals of loan-loss reserves.” While loan growth seen in the first quarter isn’t a clear indication that we are back on track, it does provide signs that the lending environment is in fact improving. Although all the results have not been accounted for yet, the latest data has shown that overall bank loans grew from a year earlier at an average of 2.5%.

This pace is very similar to what occurred in the final quarter of 2013. As you can see in the FRED graph, there was a strong increase in the total value of loans towards the end of 2013.

While this may look rather attractive, but there is still room for improvement. These rates and values can decrease very quickly, especially if lenders are holding too much collateral. This means that our economy needs to continue to move forward and it all depends on how the Fed decides to solve the problem for banks. Michael Ivanovitch writes, in a CNBC article, that he believes the Fed is aware of the situation we are currently in; currently there is still weak bank lending, which is stalling our growth in the U.S.

“Monthly asset purchases—on top of a virtually zero percent interest rate—have been a relatively easy part of a sweeping crisis management. The verdict on that policy is given by America’s demand, output and employment. It is perhaps time to adjust policy instruments and intermediation techniques to address some apparently structural issues whose solution does not seem to be in the wall of money thrown at the U.S. economy.”

While we at least have seen a stabilization following a long period of declining rates of loan growth, this is something we must still be aware of. The FRED graph has been allowed a number of interpretations to be good for the economy, but there are still weaknesses. Housing has begun to cool is recent pace and we are nowhere near enough to offset the losses already incurred. What I believe will keep our economy stable for the summer months will be a couple key decisions made by the Fed and how investors will respond to all the recent buzz. If nobody gets too anxious and jumps the gun, banks will be confident in lending allowing for an increased pace in our economy.

Output Over the Years

fredgraph

As we can see, this graph represents GDP, or output in the last 66 years. It is also clear that all of this is based on 2009 Dollars. This means that it is real GDP, as opposed to nominal GDP. It does not take the price level into account. Overall, we have noticed an upward trend with an increasing slope. In 1947, year 1, real GDP was about $2 trillion.

We can see that the first real slump is between 1973-1975. The slope of the graph is negative at that point. The reason for this is that there was an recession during that time. Two causes of this were an oil crisis and a stock market crash. Furthermore, other nations were developing. This increased competition in industries, such as steel, for North American and European countries. This forced them to re-structure the cores of their industrial areas. The stock market crash opened everyone’s eyes to this economic downturn.

The next recession happened between 2008-2009. The United States economy is still recovering from it to this day. The main cause was the large amount of sub-prime mortgage loans that banks were issuing. These mortgage-backed securities, MBS, were not very liquid assets. When the housing market popped, then the securities took a large hit. just like the recession in the mid 70’s, the slope of the line in the graph is negative. Overall, this recession saw a large loss in money for financial institutions. This is why it is considered to be the worst downturn since the Great Depression.

At the end of the graph, which is in the year 2013, real GDP is at about $16 trillion dollars. This is  8 times as much as it was in 1947. Using knowledge of logarithms, and the rule of 70, we can conclude that the economy grew about 210% over the span of 66 years. Output being 8 times larger means that it doubled three times. Each time output doubles, there is a growth of 70% in platonic terms. Three doublings would mean that the economy grew 210%.

Going back the recession of 2008, a speculation can be made, under a few conditions. If the financial crisis did not happen, and the upward trend of real GDP growth continued, output would be at about $17 trillion. The recession set the economy back by  about $1 trillion. In my opinion, this means that the current economic slump will be over when the economy’s output makes up for that $1 trillion. This is not to be treated like a debt, but more like staying on course. The economy will need to keep increasing output in order to get out of the downturn.

China’s Stimulus Package for Growth

In the past few months, the market focus has been on the Federal Reserve’s exit strategy and a slowdown of China’s economic growth. Regarding the latter one, China’s economy is expected to grow at somewhere around 7% in the first quarter, a level significantly below the double-digit growth many years ago and the 7.7% growth last year.

Since the country has set a target of 7.5% economic expansion for 2014, the first-quarter performance triggered further concern about its growth momentum. In response to that, China’s State Council, the government’s executive body, unveiled Wednesday a stimulus package to boost growth, including additional spending on railways, upgraded housing for low-income households, and tax relief for small businesses.

Although the package is considered as a mini one compared to the four trillion yuan ($650 billion) program rolled out in late 2008 amid the global financial crisis, it would still impact the overall economy in many ways.

Stimulus 1: Additional Spending on Railways

The government would further develop infrastructure through accelerated railway construction, particularly in the nation’s central and western regions, and more aggressive financing. Some operations in the public interest would be subsidized and 150 billion yuan ($24.6 billion) in bonds would be offered by the government to finance construction for the railways. Relatively, the stock prices of companies in the railway sector rallied, as shares of China Railway Group surged 5.1% and China Railway Construction Corporation’s shares jumped 7.2%.

Personally, I think the stimulus will have a double-sided effect. Positively, tremendous infrastructure construction will boost growth effectively, and the emphasis on development in the central and western region will lead to more balanced economic landscape across the country. Negatively, as China is undergoing a significant transition from being overly dependent on investment and export to relying more on domestic consumption, the massive government-led investment project might impede structural reform, and the increasing credit along with financing might pose additional risk in the credit market.

Stimulus 2: Upgraded Housing for Low-Income Households

The government would also spend more on slum clearance and upgrade of poorer urban areas. It added that the China Development Bank, a lender for key government policy projects, would set up a special arm to issue bonds to support new homes.

I think this measure could be a complement to the railway construction because of its focus on ordinary people’s well-being. It is a tradition that Chinese people care a lot about their housing and treat it as the most important measure of their living standard. Despite that the implementation of housing upgrade is yet to see, this proactive approach could ease social instability and unleash the potential of domestic consumption in the mid- to long-run.

Stimulus 3: Tax Relief for Small Businesses

The government would extend existing tax breaks to small businesses until the end of 2016 and raise the threshold for taxing smaller businesses, which have been struggling as economic growth slows.

Personally, I do believe that small businesses will benefit from decreasing tax burden, but this measure cannot address their problem radically, which is due to the lack of financing. So the government should also accelerate the financial-sector reform by incorporating private capital and diversifying lending channels for small businesses.

Economics of intellectual property laws

As reported in the Wall Street Journal, Thailand has strengthened its intellectual property laws.  Long considered one of the worst countries for property laws, the article focuses on the country’s recent efforts in copyright law as related to music. Long considered a hotbed for piracy and counterfeit merchandise, this could signal that one emerging market is ready to grow.

The United States has some of the best property rights in the World.  However, in some cases, even the holders of some US copyrights have found that it is best not to defend them.  As the RIAA has found out, it may not be worth the trouble.  Thailand is responding to lawsuits brought by GMM Grammy, a Thai record label, against local performers who have been playing “…whatever people want to hear”.  These lawsuits are unpopular with the public, who compare the music style to American Jazz.  Music aside however, what might the economic ramifications be if Thailand was actually serious about protecting intellectual property?

Upon closer inspection, Thailand’s copyright laws rank a mathematically impossible 23rd out of 18 in its region. Typo aside, Thailand would seem to be in desperate need of property laws. Research by Keith Maskus shows that they could see more benefits then just the musical innovation.  Intellectual property laws by themselves don’t stimulate foreign investment in developing countries; If that where the case, Botswana would have more foreign investment then Italy.  Maskus’s research shows that while ultimately it is a choice at the firm level about whether to directly invest in a foreign country or not, the level of legal protection must be considered.

If the country can manufacture modern goods, as well as having a market to sell them in, then property laws can provide incentive for foreign investment.   Thailand fits this definition.

Even if the effect of enhanced IP laws isn’t foreign investment, there are still very compelling economic reasons for Thailand to protect its ideas.  Such laws encourage innovation as opposed to imitation, as well as ensure that those responsible for an idea get compensated for their work.  While IP laws can be imposed to early, creating economic inefficiencies, Thailand may have developed enough to warrant some protection, and that is something they should use as a sign of their economic success.

Emerging markets have been taking a beating recently.  Recent political unrest has resulted in a worsening economic outlook for Thailand.  Thailand can reverse this course and return to being the fastest growing economy in the world.  Thailand can do this by focusing on the property rights that matter.  Once the country has its political house in order, its experimentation with music copyrights should be expanded into patents and private property.

 

 

Positives Signs in Europe

Recently, multiple economies in the Eurozone experienced serious downturns. One the most troubled economies was Greece. In fact, Greece was the origin of this economic crisis in Europe. This can be seen with a decrease in yield for Greek bonds. According to a chart in the Wall Street Journal, Greek bond yields have dropped to 6.828%. During the peak of Greece’s economic problems, which were in 2012, the yields were very close to 35%. In the near future, there will be a €8 billion, or $11 billion buyout to pay back bonds that are maturing. The country is also feeling optimistic. Alpha Bank expects the economy to grow 1.1% this year.

Greece’s silver linings could be attributed to the positive outlooks for the rest of the Eurozone. There is an article by David Jolly in the New York Times about this. Part of this economic growth is the unexpected improvement in the French economy. The article discusses Markit’s composit index of economic activity, which is based on a survey of purchasing managers. If this survey were to generate a reading of 50 or higher, then this would mean that there is economic growth. Anything below 50 would represent contraction. The reading for this month was 53.2, which means that there is growth. Last month’s reading was 53.3, which is the highest reading in the last 32 months.

An article in the Washington Post from about a month ago explores growth in various countries in the Eurozone. The GDP grew by about .3% from October to December, which contributes to an analyzed rate of 1.2%. According to this article, growth in the third quarter was a little slow, but it picked up in the fourth quarter. Part of the reason for this was activity that was higher than expected in Germany, France and Italy, some of the Eurozone’s biggest economies. These fourth quarter growths were .4%, .3% and .1%, respectively. The Netherlands achieved growth rates of .7%, and two other troubled economies, Spain and Portugal grew by .3% and by .4%, respectively.

In a previous post, I mentioned that there is more than what meets the eye in economic data. Mankiel confirms this in his book. Previous trends are not always the best way about making investment decisions because an investment moves in a random pattern. There is no way to be sure if it will go up, down, sideways or back and forth. The same can be said about an economy. Recent figures have shown that Europe is seeing economic recovery. Even some of the troubled countries, such as Greece, Spain and Portugal are recovering. The Markit index for France is showing a reading above 50, so we know that its economy is growing. However, we do not know what will happen in the future. Some event, such as another liquidity crisis, could happen that could have a large impact on the Eurozone. If this were to happen, a lot of economies would tank. We have no way of predicting this, much like how we have no way of predicting where an investment will go in the future.

 

What Caused the Fluctuations in Commodity Prices?

Our discussion over commodity prices in today’s class really triggered my interest. As Professor Kimball said, the price of copper at time t is equal to the sum of extraction cost and its value at time t, while the present value is the real value at time t+1 discounted by the real interest rate at time t.

Relatively, John Taylor argued that:

There is yet another downside. Foreign central banks—whether they like it or not—tend to follow other central banks’ easy-money policies to prevent their currency from appreciating sharply, which would put their exporters at a disadvantage. The recent effort of the new Japanese government to force quantitative easing on the Bank of Japan and thus resist dollar depreciation against the yen vividly makes this point. This global increase in money risks commodity booms and busts as we saw in 2011 and 2012.

His argument certainly is unconvincing based on the calculation above, and I also disagree with him on the worldwide impact of the US quantitative easing. After the burst of the 2008 global financial crisis, major economies went into recession and therefore, it is absolutely reasonable for central banks around the global to conduct expansionary monetary policy to stimulate economic growth. So the increasing liquidity itself, as a growth momentum, is not a bad thing.

In particular, I think commodity prices have a lot more to do with global demand and economic growth in some particular countries instead of the monetary policy of central banks.

Copper prices fell to a seven-month low today on concerns about an economic slowdown and the health of financial system in China.

Last weekend, China reported that its exports fell 18% in February from a year earlier, which caused the decline in copper prices because the country is the top consumer of the medal and weakening exports might be a signal of slowing growth and modest consumption.

Furthermore, the so-called “Copper Financing” in the country has significantly affected the medal’s prices. Many investors claimed that the copper market’s problems go beyond the factory floor. The cracks appearing in China’s financial system likely are playing a bigger role. Much of the copper stored in China, the world’s biggest consumer of the metal, is used by companies and investors as collateral for loans from banks and other lenders. They then invest the money in higher-yielding assets. So the emerging concern is that the recent drop in copper prices might lead to a vicious circle in China’s copper demand as banks are becoming reluctant to accept copper as collateral.

So why can “Copper Financing” be a thing in China? It has to do with the shadow banking system in the country. As Professor Kimball said in today’s class, state-owned banks mainly make loans to state-owned enterprises in China, and therefore, many small and medium enterprises have confronted the financing problem. Consequently, they have to turn to some other channels for financing.

Nevertheless, I am still optimistic about the future demand of copper in China as the newly-established administration is determined to roll out structural reform initiatives and allows the market force to play a bigger role in the overall economy. In the financial sector, the Chinese central bank is trying to increase the flexibility of the yuan as it weakened the daily reference rate for its currency by the largest percentage in more than a year and a half on this Monday, which could stimulate the country’s exports and ensure financial stability in the long run. In addition, the government is expected to curb speculation and enhance credit quality by imposing stricter restriction on the shadow banking system.

Can a Cup of Java Wake Coca Cola Up?

Almost two weeks ago, I was watching options activity of Green Mountain Coffee Roasters before the bell closed to try and get a gauge of where the so-called “smart money” was placing its bets before the earnings call scheduled to take place. I did not end up placing a bet of my own (a lesson I have learned by being on the wrong side of those calls one too many times in recent history, but I digress..) but a few things stuck out to me: there was outrageous options activity on both the bullish and bearish sides of the stock and there were a few very large blocks of options traded on the bullish side quite close to the end of the day. Even so, the market closed and I had my bets on GMCR missing the quarter partially due to my own knowledge of the company as well as the overall options signals. But then before the call began, something interesting happened. The stock was halted in post market trading and it was announced that Coca Cola had entered into an agreement to take a 10% stake in the company and the stock literally blew up. I had missed my chance for the initial pop, but I wondered, would Coke be a good investment at this point? Well the WSJ came along to answer some of my questions.

Coke is one of the longest standing and most valuable companies out there; worth somewhere around 80 billion. the company had been the model of growth stocks for many years– the WSJ also talks about how a single share from the early 1900’s is worth over $10m today. Recently though, it seems the company (like Buffalo Wild Wings) has been going through a bit of an identity crisis, or maybe that depends on who you talk to. You see, as much growth as Coke has gone through in the past 100 years it comes to a point where it is no longer possible — and as one of the largest if not THE largest globally recognized brands, they seem to be running out of places to go. This seems to be the ideal time where a growth stock becomes a sort of income or value stock that can be held or traded. The WSJ article shows that Coke had over an $8b cash flow last year and they have consistently repaid all of their earnings back out to investors– this is something to look for in an income stock. With the acquisition, and possibly the eventual outright purchase of GMCR I think that Coke presents an interesting opportunity; a company that consistently treats its shareholders well and returns everything possible, with a new potential growth opportunity in home consumables.

While it is definitely too early to tell what will come of this acquisition, I believe that Coke could have just bought themselves some growth. The sector of home beverage production, I think, is more than just a passing fad that should have investors salivating. I have to believe that the grand plan could be for coke to have a machine that could produce whatever drinks you want from coffee to cola in the push of a button from the comfort of your own home. This could be the turning of the tides for a sometimes glossed over stock.