The markets are closed today in observance of Martin Luther King, Jr. day.
With that in mind, we’re stepping back from our usual daily analysis of the markets to address the big picture for the investment landscape in 2013.
Popular Delusion #1: The investment world believes China will engage in another massive round of stimulus.
This will not be the case. China’s new ruling party has stated point blank that the country will not be engaging in rampant stimulus (for the obvious reasons of rising inflation):
This may sound like an oxymoron, but China’s new Communist government is turning away from financial stimulus to help its slow-moving economy.
During the party’s two-day Central Economic Work Conference this weekend, party leader Xi Jinping said the country would essentially not be pursuing high growth rates through stimulus. That doesn’t mean that Beijing has turned sour on fixed asset investments on things like roads, bridges and subways. They’re still going through with major urbanization projects. But whenever the economy is slowing, the new leaders say they will be less likely to prime the pump.
China’s market has rallied over 16% in the last month on the belief that China will engage in another large-scale stimulus plan… despite China’s leaders stating they will not. This has the makings of a very nasty correction.
Popular Delusion #2: Japan’s new leadership will be able to kick off an even more aggressive monetary intervention.
Truth be told, Japan is on the cusp of the mother of all debt implosions. Case in point, Japan’s Yen is thought to be a safe haven. With that in mind, it’s critical to note that when the EU Crisis hit in mid-2012, the Yen fell. Indeed, it has now taken out its trendline:
Indeed, it is interesting to note that political leaders Japan, like those in Europe and the US, have begun to use verbal intervention as a primary tool. Prime Minister Shinzo Abe took office urging the Bank of Japan to act even more aggressively, even threatening to strip the bank of its independence.
Since that time, the Nikkei has erupted higher. The Japanese Government got what it was looking for, and Japanese Economic Minister Amari announced that the Yen was correcting in line with fundamentals.
Take note, this series of events indicate that Japanese leaders will likely engage in verbal intervention to get what they want. It’s worked for the EU and US.
Popular Delusion #3: The US bond bubble will burst in 2013.
It’s become increasingly common to see calls for the US bond bubble to implode this year. To be clear, the US’s financial situation is terrible. But it is nothing compared to the financial situation in Europe, Japan, and China.
Europe has not recapitalized its banks. Many of its countries’ entire banking systems are insolvent. The EU banking system as a whole is leveraged at 26 to 1 (Lehman was at 30 to 1 when it went bust). Even Germany’s banking system is in worse shape than the US’s (the US recapitalized its banks following the 2008 crisis. Europe. including Germany, has not).
China’s true Debt to GDP is over 200%. Already in a hard landing, the country is now facing several major problems, namely looming water and agriculture crises, food inflation and accompanying civil unrest, and the potential of armed conflict with Japan.
Moreover, the belief that China will shift over to a consumer economy is misguided. Consumption has increased by 9% per year in China for 30 years now. The China consumer is not somehow dormant. And as more and more manufacturing firms leave China for more stable markets (Apple, Ford, GE, Bridgestone, have all announced they are moving facilities back to the US), China will be facing rising unemployment.
Finally, and most critically, financial institutions are desperate for high-grade collateral in the form of quality sovereign bonds. Say what you will about the US, it remains the most liquid market for debt in the world. And if you had a choice between lending money to the US, Japanese, any European, or the Chinese Government, the US is the obvious answer.
This is not to say the US is in great shape. Instead, we would argue that the US is the least ugly of the major debt markets. The US bond bubble will burst at some point. But it will likely not do so in 2013.
To conclude, the world Central Banks and EU politicians have done everything imaginable to postpone the EU crisis. They’re now out of options. The EU crisis will very likely erupt anew in the first half of 2013. Meanwhile Japan is waiting in the wings. And China has its own issues to contend with.
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