gavekal's four scenarios-

[jk]

surprise:rolleyes:, they're bullish on equities and the dollar!

Gavekal’s four scenarios for what lies ahead

The markets right now are facing an unusually high level of uncertainty, whether it be about future growth, the nature of banks’ balance sheets, the ultimate impact of the housing slowdown, the ability of banks to extend future loans…and, of course, how the new Fed chairman will react to all of this.
In their client newsletter, the pundits at Gavekal, the Hong Kong-based independent research and investment house, have neatly outlined four possible scenarios for the financial environment ahead.

• Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further and the US economy grows past its credit crunch. If this happens, it would be massively bullish for the dollar, massively bearish for gold and potentially bearish for HK and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for US Treasuries and government bonds around the world. Additionally, we would most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) towards the more traditional “growth” sectors, such as technology, health care, consumer goods, and maybe even Japanese equities.
• Scenario 2: The Fed sticks to its guns, does not cut rates, and the US economy really tanks under the weight of the credit crunch. In essence, the US would move into a Japanese-style “deflationary bust”. In this scenario, equities around the world, commodities, and the dollar would collapse, while government bonds would go through the roof.
• Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the US$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.
• Scenario 4: The Fed ultimately cuts rates, and succeeds in reining in the economy. This would be good news for equity markets, commodity markets, and the dollar, but of course, terrible news for bonds.

The market is still adamantly betting on Scenario 3, and thus one has to be concerned that the Fed’s hand could once again be forced by the market to cut. However, having learned from past experience, Bernanke should now work harder to rein in expectations, particularly as the data continues to point toward a resilient US economy. And with the weak dollar and continued growth around the world, rising exports should help counter any slack in domestic consumption (which has not yet fallen off a cliff) and the US housing slowdown (which should have a fairly limited impact on the overall economy).
Additionally, the steepening yield curve should begin to help banks rebuild their balance sheets, and thus the Fed may actually feel that it has already done its part in resolving this crisis. Given the above, Gavekal concludes that it is quite likely the market will be surprised to see Scenario 1 unfold.



http://ftalphaville.ft.com/blog/2007...at-lies-ahead/

[Guest]

Re: gavekal's four scenarios-

JK -

Mauldin seems to think they (the US) are now on a "monorail" to cut, and cut repeatedly.

Have not had time to read all his recent posts, but that's been a recurring theme of his in more than one. Read this view on one or two other writers also. For what it's worth, these people seem to see significant difficulties in the US adopting a genuinely austere interest rate policy going forward.

[c1ue]

Re: gavekal's four scenarios-

I'm surprised GaveKal isn't talking about a possible China effect on the whole equation - implying that the US is still in the driver seat.

One scenario which has some resonance for me is China raising the RMB peg to offset dollar devaluation related increases in commodity prices.

As a sanity check - I look at the Chinese subsidy of gasoline.

I'm not sure I can agree with the IAGS cost of gasoline of $5.28/gallon - GRG? comment? - but it is likely above the actual present pump price.

http://www.iags.org/costofoil.html

However, if I do assume a cost basis of around $4/gallon vs. $2.44/gallon pump prices, it implies that China's government is spending $80B/year in subsidizing gasoline costs ($1.56 * 7 M bpd * 19.5 gallons gasoline/barrel oil * 365 days/year). Changing the cost basis to present price drops the subsidy to perhaps $20B/year.

This is chump change for the US, but even with China's unofficial budgets around $100B and official budget at $25B - this is not chump change for the Chinese government.

Thus the idea that China might allow the RMB to achieve its 'natural' higher value to defray this energy (plus commodity import) cost is not out of the question.

[Jim Nickerson]

Re: gavekal's four scenarios-

surprise:rolleyes:, they're bullish on equities and the dollar!

Gavekal’s four scenarios for what lies ahead

The markets right now are facing an unusually high level of uncertainty, whether it be about future growth, the nature of banks’ balance sheets, the ultimate impact of the housing slowdown, the ability of banks to extend future loans…and, of course, how the new Fed chairman will react to all of this.
In their client newsletter, the pundits at Gavekal, the Hong Kong-based independent research and investment house, have neatly outlined four possible scenarios for the financial environment ahead.

• Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further and the US economy grows past its credit crunch. If this happens, it would be massively bullish for the dollar, massively bearish for gold and potentially bearish for HK and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for US Treasuries and government bonds around the world. Additionally, we would most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) towards the more traditional “growth” sectors, such as technology, health care, consumer goods, and maybe even Japanese equities.
• Scenario 2: The Fed sticks to its guns, does not cut rates, and the US economy really tanks under the weight of the credit crunch. In essence, the US would move into a Japanese-style “deflationary bust”. In this scenario, equities around the world, commodities, and the dollar would collapse, while government bonds would go through the roof.
• Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the US$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.
• Scenario 4: The Fed ultimately cuts rates, and succeeds in reining in the economy. This would be good news for equity markets, commodity markets, and the dollar, but of course, terrible news for bonds.

The market is still adamantly betting on Scenario 3, and thus one has to be concerned that the Fed’s hand could once again be forced by the market to cut. However, having learned from past experience, Bernanke should now work harder to rein in expectations, particularly as the data continues to point toward a resilient US economy. And with the weak dollar and continued growth around the world, rising exports should help counter any slack in domestic consumption (which has not yet fallen off a cliff) and the US housing slowdown (which should have a fairly limited impact on the overall economy).
Additionally, the steepening yield curve should begin to help banks rebuild their balance sheets, and thus the Fed may actually feel that it has already done its part in resolving this crisis. Given the above, Gavekal concludes that it is quite likely the market will be surprised to see Scenario 1 unfold.



http://ftalphaville.ft.com/blog/2007...at-lies-ahead/

So, jk, how do you see it playing out?

I'm of the opinion--based on smarter people's opinions--that this issue with all the credit derivatives has a helluva lot more unwinding as does the housing market bubble-burst and its ultimate effects. I guess that mostly translates into Gavekal 3. The stumper is why do treasuries' yields keep going lower? Is that all flight-to-safety? or deflation?

[touchring]

Re: gavekal's four scenarios-

Scenario 1 is impossible. It assumes that the success home supply will disappear overnight. Just like oil prices won't stop rising because of demand, home prices won't stop falling until all the excess supply is mopped up.

Supply and demand, the most basic and most complex economic concept.

[GRG55]

Re: gavekal's four scenarios-

So, jk, how do you see it playing out?

I'm of the opinion--based on smarter people's opinions--that this issue with all the credit derivatives has a helluva lot more unwinding as does the housing market bubble-burst and its ultimate effects. I guess that mostly translates into Gavekal 3. The stumper is why do treasuries' yields keep going lower? Is that all flight-to-safety? or deflation?

Jim's well ahead of me. At least he has an opinion. I'm just confused by GaveKal's commentary. Good thing we have The Brain and the rest of you folks to straighten out guys like me. Here's my questions in no particular order:

Gavekal’s four scenarios for what lies ahead

The markets right now are facing an unusually high level of uncertainty, whether it be about future growth, the nature of banks’ balance sheets, the ultimate impact of the housing slowdown, the ability of banks to extend future loans…and, of course, how the new Fed chairman will react to all of this.
In their client newsletter, the pundits at Gavekal, the Hong Kong-based independent research and investment house, have neatly outlined four possible scenarios for the financial environment ahead.

• Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further and the US economy grows past its credit crunch. If this happens, it would be massively bullish for the dollar, massively bearish for gold and potentially bearish for HK and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for US Treasuries and government bonds around the world. Additionally, we would most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) towards the more traditional “growth” sectors, such as technology, health care, consumer goods, and maybe even Japanese equities.
• Scenario 2: The Fed sticks to its guns, does not cut rates, and the US economy really tanks under the weight of the credit crunch. In essence, the US would move into a Japanese-style “deflationary bust”. In this scenario, equities around the world, commodities, and the dollar would collapse, while government bonds would go through the roof.
• Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the US$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.
• Scenario 4: The Fed ultimately cuts rates, and succeeds in reining in the economy. This would be good news for equity markets, commodity markets, and the dollar, but of course, terrible news for bonds.

The market is still adamantly betting on Scenario 3, and thus one has to be concerned that the Fed’s hand could once again be forced by the market to cut. However, having learned from past experience, Bernanke should now work harder to rein in expectations, particularly as the data continues to point toward a resilient US economy. And with the weak dollar and continued growth around the world, rising exports should help counter any slack in domestic consumption (which has not yet fallen off a cliff) and the US housing slowdown (which should have a fairly limited impact on the overall economy).
Additionally, the steepening yield curve should begin to help banks rebuild their balance sheets, and thus the Fed may actually feel that it has already done its part in resolving this crisis. Given the above, Gavekal concludes that it is quite likely the market will be surprised to see Scenario 1 unfold.

• In Scenario 4 how does the Fed "succeed in reigning in the economy" by cutting rates? Evidently six months after joing iTulip I still can't get the basics right. Hell, I thought the problem was a slowing US economy, and didn't even recognize it needed "reigning in".
• If the market is "adamantly betting" on Scenario 3 (or any other scenario for that matter) then why do we have a schizophrenic market with a 200-300 point, 90% Dow up day followed by just the opposite in the same week? Doesn't this volatility indicate the market isn't adamant about anything, other than more uncertainty? I am sooooo confused. :confused:
• In Scenario 1 if "the US economy grows past its credit crunch" does that not imply that credit has once again been expanding to support that growth, or is there a mechanism whereby the US economy can grow past its credit crunch without more credit? In the absence of the latter, how does GaveKal reconcile renewed (and immediate) credit expansion with rotation away from commodities and cyclicals? Are they expecting the US to quickly revert to an economy where the biggest export is once again commodity-lite financial toxic-waste? Come to think of it, didn't commodities do rather well the last time they tried that stunt earlier this decade? Then again maybe the US becomes a nation of consultants (the ultimate service economy) and makes absolutely nothing tangible ever again?
• Some data appears to point to a resilient US economy (exports of commodity intensive Boeings and John Deere's for example) but other economic data is clearly abysmal. What happens to retail sales when the falling dollar finally works through to import prices after the normal lag?
• Is GaveKal ascribing more power to the Fed than it really has? In Scenario 2 they speak about the Fed not cutting rates. But it sure looks like what EJ predicted quite some time ago is exactly what is happening - the Fed is behind the curve and following market rates down. Under the current situation wouldn't the Fed have to conduct a large number of aggressive operations to "hold" the short market rate up at their "neutral" Fed rate in the face of the "deflationary bust" and "bonds through the roof" of Scenario 2?
• The last sentence is not at all clear. Perhaps "the market will be surprised to see Scenario 1 unfold", but so what. Is that Scenario 1 what GaveKal believes most probable? This write up doesn't really say, but perhaps I missed something in my confused state... :p

Over to y'all.

[touchring]

Re: gavekal's four scenarios-

So, jk, how do you see it playing out?

I'm of the opinion--based on smarter people's opinions--that this issue with all the credit derivatives has a helluva lot more unwinding as does the housing market bubble-burst and its ultimate effects. I guess that mostly translates into Gavekal 3. The stumper is why do treasuries' yields keep going lower? Is that all flight-to-safety? or deflation?

What you described might be a rough combo of 2 and 3.

Inflation in gold, precious metals, and maybe food commodities, but deflation in fixed assets and commodities related to fixed asset investment like copper, iron and nickel.

A Zimbabwean situation!

http://bloomberg.com/apps/news?pid=2...s&refer=africa

Nov. 16 (Bloomberg) -- Zimbabwe's annual inflation rate soared to 14,841 percent in October as food and fuel costs jumped, the Central Statistical Office said.

In a bid to rein in inflation, the government in June imposed prices controls on goods and services, forcing companies to slash prices by half. The decree led to widespread shortages and empty supermarket shelves.

btw, i thought that e-gold might become the strongest currency in such a scenario, any opinions? ;)

[jk]

Re: gavekal's four scenarios-

JHere's my questions in no particular order:

fwiw, here are the answers i can come up with

• In Scenario 4 how does the Fed "succeed in reigning in the economy" by cutting rates? Evidently six months after joing iTulip I still can't get the basics right. Hell, I thought the problem was a slowing US economy, and didn't even recognize it needed "reigning in".

gavekal people are native french speakers. they don't mean "reining in" in the sense of slowing, e.g. we would say that the chinese are attempting to rein in overly rapid growth. they mean reining in the economy's problems.

• If the market is "adamantly betting" on Scenario 3 (or any other scenario for that matter) then why do we have a schizophrenic market with a 200-300 point, 90% Dow up day followed by just the opposite in the same week? Doesn't this volatility indicate the market isn't adamant about anything, other than more uncertainty? I am sooooo confused. :confused:

"adamantly betting on scenario 3" means that gavekal's predictions about the euro, the dollar and gold have been wildly off the mark. these are the "adamant bets" they have in mind. they have been bullish on equities and, for all their recent volatility, GLOBAL equities have done well.

• In Scenario 1 if "the US economy grows past its credit crunch" does that not imply that credit has once again been expanding to support that growth, or is there a mechanism whereby the US economy can grow past its credit crunch without more credit? In the absence of the latter, how does GaveKal reconcile renewed (and immediate) credit expansion with rotation away from commodities and cyclicals? Are they expecting the US to quickly revert to an economy where the biggest export is once again commodity-lite financial toxic-waste? Come to think of it, didn't commodities do rather well the last time they tried that stunt earlier this decade? Then again maybe the US becomes a nation of consultants (the ultimate service economy) and makes absolutely nothing tangible ever again?

the bullish scenario is that the u.s. avoids a recession because export industries grow, supported by strong asian and somewhat-less-strong european markets. exports are supposed to compensate for the collapse of housing. in this scenario there is diminished dependence on domestic consumption, and therefore also less dependence on domestic credit growth.

a side comment: gavekal focuses more on profits than on gross receipts. e.g. apple can make big profits on ipods even as the trade deficit looks worse because all those ipods are manufactured abroad. my comment here is that the profits are real but accrue to stockholders and financial market players - in general, the wealthy. this supports the u.s.'s gradual slide toward plutonomy. since gavekal subscribers are plutocrats, they are not concerned about this implication. see the itulip thread on plutonomy:
http://www.itulip.com/forums/showthr...ight=plutonomy

• Some data appears to point to a resilient US economy (exports of commodity intensive Boeings and John Deere's for example) but other economic data is clearly abysmal. What happens to retail sales when the falling dollar finally works through to import prices after the normal lag?

in gavekal scenario 1, as i interpret it, u.s. export industries throw off enough income, and u.s. companies more generally throw off enough profit, to pump up the rest of the economy, and this effect is sufficient to maintain retail sales.

• Is GaveKal ascribing more power to the Fed than it really has? In Scenario 2 they speak about the Fed not cutting rates. But it sure looks like what EJ predicted quite some time ago is exactly what is happening - the Fed is behind the curve and following market rates down. Under the current situation wouldn't the Fed have to conduct a large number of aggressive operations to "hold" the short market rate up at their "neutral" Fed rate in the face of the "deflationary bust" and "bonds through the roof" of Scenario 2?

gavekal isn't ascribing the u.s. economy's putative revival to further fed action at all. in scenario 1 the fed doesn't do much more than it has already done. the "power" is in the dynamic u.s. economy.

• The last sentence is not at all clear. Perhaps "the market will be surprised to see Scenario 1 unfold", but so what. Is that Scenario 1 what GaveKal believes most probable? This write up doesn't really say, but perhaps I missed something in my confused state... :p

as i read it, gavekal is predicting scenario 1. this bullish outcome is what they have been predicting for years. [their most recent book is titled "the end is not nigh."] they've been right about global equities [so far] and wrong about currencies and gold [so far].

[GRG55]

Re: gavekal's four scenarios-

[/list]the bullish scenario is that the u.s. avoids a recession because export industries grow, supported by strong asian and somewhat-less-strong european markets. exports are supposed to compensate for the collapse of housing. in this scenario there is diminished dependence on domestic consumption, and therefore also less dependence on domestic credit growth.

a side comment: gavekal focuses more on profits than on gross receipts. e.g. apple can make big profits on ipods even as the trade deficit looks worse because all those ipods are manufactured abroad. my comment here is that the profits are real but accrue to stockholders and financial market players - in general, the wealthy. this supports the u.s.'s gradual slide toward plutonomy. since gavekal subscribers are plutocrats, they are not concerned about this implication. see the itulip thread on plutonomy:
http://www.itulip.com/forums/showthr...ight=plutonomy
[/list]in gavekal scenario 1, as i interpret it, u.s. export industries throw off enough income, and u.s. companies more generally throw off enough profit, to pump up the rest of the economy, and this effect is sufficient to maintain retail sales.[/list]gavekal isn't ascribing the u.s. economy's putative revival to further fed action at all. in scenario 1 the fed doesn't do much more than it has already done. the "power" is in the dynamic u.s. economy.
[/list]as i read it, gavekal is predicting scenario 1. this bullish outcome is what they have been predicting for years. [their most recent book is titled "the end is not nigh."] they've been right about global equities [so far] and wrong about currencies and gold [so far].

Thanks jk. That does help clarify.

Merrill's David Rosenberg was being interviewed today and pointed out that about 60% of US exports are to Canada, Japan, Mexico, UK, Europe all of which are now slowing down. Apparently he is sceptical of the "exports will keep the US economic engine running" story. Given where Boeing, Cat, Deere, etc sell most of their output now, I am not completely convinced of his argument, but definitely something to monitor.

[Spartacus]

Re: gavekal's four scenarios-

[*]Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the US$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.

so they
1. know what "the market" (ie, everyone) guesses is going to happen
1a know what "the market" predicts about the effects of these guesses
2. know that if everyone thought that, what the exact effects in the world would be right now (especially prices)
3. know that if everyone thought that, what the exact effects in the world would be in the future (especially prices)

wow .... this is "analysis" ?
mind reading
mass mind reading
mass mind reading about hypothetical situations
omniscience (present)
omniscience (future)

Can you find any more delusions in those 2 sentences?

[DemonD]

Re: gavekal's four scenarios-

isn't scenario 3 already happening?

and now i get to play pessimist:

The market is still adamantly betting on Scenario 3, and thus one has to be concerned that the Fed’s hand could once again be forced by the market to cut.

I disagree. If this were so then gold would already be over a thousand and google would be back under 500. It would be a "disorderly" decline of the dollar, and there are enough people out there that are still putting capital into dollar-based investments.

If there is one criticism I have of Gavekal it's that they are way too pollyanna about asia in general and china in particular. I see no where in their analysis that allows for a contraction in asia, and to have no scenario even thought about like that to me is maybe drinking too much of their own punch.

So yes, jk, I think I'm in agreement with your snarky assessment.

[Guest]

Re: gavekal's four scenarios-

JK -

A pre-holiday bulletin from Stephen Leeb's "Complete Investor" newsletter. He's known as leaning towards conservative in his portfolios, but he's also been rated one of the top 3-5 market timers in the country in the past 6 - 7 years. FWIW.

Of course, Leeb has been a proponent of the inevitability of $250 - $300 oil for the past seven years, which may affect his overall credibility in some quarters. He was one of the very earliest ones to suggest / forecast, that this was coming, back when oil was under $20 USD, and his thesis regarding oil was that this would be driven by fundamentals, not by inflation. Inflation for him has always been the corrolary.

Mr. Leeb took two MA's and a PHD concurrently (in mathematics and psychology) and completed them in 3 years. He is frequently correct on his very short term market calls, just as he often is on the decade long macro calls. A significantly strengthening dollar is not in his forecasts.

________________

November 21, 2007 Trading during holiday shortened weeks are supposed to be quiet affairs with an upward bias...at least that's been the historical norm. We'd say it has been anything but quiet in recent days. Continued uncertainty about how the credit crisis will play itself out deserves the lion's share of the blame.
Stocks sold off on Monday with the Dow Industrials surrendering more than 200 points after a Goldman Sachs analyst downgraded Citigroup. There wasn't any actual bad news on Citi, mind you; just an analyst getting out a sell signal after the stock was off 25 percent in the pervious month. Yesterday stocks overall held their own, but Freddie Mac and Fannie Mae, the quasi-government agencies tasked with creating liquidity in the mortgage market, plunged 29 and 25 percent, respectively, to their lowest levels in more than a decade.

Freddie Mac indicated that the company’s losses from sour mortgages would probably exceed $10 billion, more than double what the company has already written off. This morning, with no catalyst to encourage buyers, the selling continues. We're likely at or very near the point of maximum fear in the credit markets. Historically such crises have proven to be excellent buying opportunities. It's a safe bet the Federal Reserve will continue to prime the pumps to prevent the financial system from seizing up.

At this point we'd bank on another 50 basis point rate cut in December. A telling indication of lower rates ahead is the favorable action in utility shares of late. No doubt the economy is set to slow in the coming months, but the leading indicators continue to suggest we'll avoid an outright recession. And those lower rates will set the stage for stronger growth (and greater inflation) down the road.
Of course we'll continue to monitor important gauges for signs that the situation is deteriorating. For now industrial commodity prices remain near record highs. That's important since these are the fundamental building blocks of the economy. We have, however, noticed a growing divergence between large cap and the more economically sensitive small cap stocks, which is a bit worrisome, but not alarmingly so. Likewise, unemployment insurance claims have ticked higher but remain out of the danger zone.

Let's not forget oil, which has rebounded strongly in the last few weeks. Prices are approaching $100 a barrel again. We try not to place too much emphasis on the weekly oil inventory data, but today's numbers strongly suggest we're not going to see a big retreat in crude prices anytime soon. The energy shares are likely to move higher to reflect this reality. On the other hand, we'll really start to fret if oil prices start to approach $110 a barrel. At that level prices would start to take their real toll on the economy.

[jk]

Re: gavekal's four scenarios-

We're likely at or very near the point of maximum fear in the credit markets. Historically such crises have proven to be excellent buying opportunities. It's a safe bet the Federal Reserve will continue to prime the pumps to prevent the financial system from seizing up.

the vix is below its recent highs, so we're not quite at a point of maximum fear. and i don't know about you, but i could get a lot more afraid myself. the sell-off has been rather orderly and sedate, no huge volume, no huge gaps down. so i, at least, can imagine the fear increasing. i tend towards apocoholism, however, so i try to keep my imagination in check. it's indeed a safe bet, in my opinion, that the fed will "continue to prime the pumps," but it remains to be seen whether this can "prevent the financial system from seizing up." the fed's single tool doesn't seem well suited for the particular, derivative focused, problems that might precipitate such a seizure.

[Guest]

Re: gavekal's four scenarios-

I rather think you tend towards considerably sobriety, JK.

i tend towards apocoholism, however, so i try to keep my imagination in check.

[c1ue]

Re: gavekal's four scenarios-

I agree with JK - fear outside of financial institutions is not yet very high.

My personal expectation of a 1 day, 1000 point drop in the Dow also hasn't been hit yet.