Tags: China | GDP | Waldorf | euro

Where's Sound Growth in the World Going to Come From?

By    |   Tuesday, 21 October 2014 09:42 AM

Maybe it's just me, but when I read that the Waldorf-Astoria hotel in New York would be sold by Hilton Worldwide Holdings to the Chinese Anbang Insurance Group for $1.95 billion in cash, I thought this remarkable event might well be a sign that indicates the Chinese economy could be bound for a slowdown for years to come. However, if that were to occur, markets certainly haven't taken it into account yet.

The Waldorf-Astoria deal made me immediately think about when in 1989 when the Rockefeller Group, which at that time owned the Rockefeller Center alongside other important real estate in new York, sold 51 percent of the company to the Japanese Mitsubishi Estate Company for $846 million in cash.

When we superimpose the charts of the Chinese Shenzhen ChiNext Price Index, after having slumped 29 percent since November 2010 and starting after the Federal Reserve announced in September 2012 its third round of quantitative easing, with the Japanese TOPIX Index, which also had lost 25 percent in the crash of 1987, we see the Waldorf-Astoria purchase and the Rockefeller Center acquisition coincide neatly in time on both charts.

As Mark Twain said: "History doesn't repeat itself, but it does rhyme." It could well be that 2015 will become a rocky year for the Chinese equity bulls. Of course, we'll have to wait and see.

Tuesday, we got the Chinese GDP number that showed the economy expanded by 7.3 percent year-over-year in the third quarter, down from 7.5 percent in second quarter. That is the weakest growth rate since 2008. The official statistics bureau commented that "pain" from restructuring contributed to the slowdown in growth in the quarter. It's interesting to take notice the Bloomberg China GDP tracker pointed to 6.9 percent growth in the third quarter, which makes me wonder which of number is closest to reality?

I always will remember when Henri Kissinger said in January 2009 that the Chinese growth rate might fall temporarily below the 7.5 percent that Chinese experts have always defined as the "line that challenges political stability." We'll see if that is still accurate.

Meanwhile, in a new National Bureau of Economic Research paper, former U.S. Treasury Secretary Larry Summers and Harvard University professor Lant Pritchett forecast Chinese GDP growth would average 4 percent for next two decades

At the same time, the business-research group The Conference Board published a study that states if China doesn't come up with serious reforms that resolve the country's productivity and debt challenges, they expect what they call a "soft fall" to growth of approximately 3 percent, including negative growth for certain sectors and regions.

I'd like to add that if only part of these forecasts come through, then the million dollar question would be: "Where's sound growth in the world going to come from?"

I'm convinced, not least of all because there is still too much debt (leverage) in the world as a whole, that substantial global growth stimuli should not be expected to come from the U.S., which is growing, but not at the sustainable strength to become the world's growth locomotive, or from the European Union, which faces a renewed threat of stagnation coupled with unacceptable high unemployment and that is in a near disinflationary environment for quite some time to come. The emerging economies from their side will have to face serious challenges once the Fed starts raising its rates some time in 2015 or 2016.

In my opinion, the world as a whole is at serious risk of an escalation of economic divergences, which is one of the lethal unintended consequences of quantitative easing (QE) even though QE is still going on and even expanding in various important economies in the world. How that finally will end, nobody knows; but I'm afraid it could turn out not being a pleasant experience.

I want to remind long-term investors to remain extremely attentive that their investments are really "liquid" under all, or nearly all, circumstances. Last week, the markets sent us a timely warning that volatility can really jump out of nowhere at any moment.

Many investors have put substantial amounts in mutual funds and exchange-traded funds, which is OK. These inflows have provided these instruments the capacity of trading assets at low costs, but on the other hand have caused a weakening, or a mismatch, in the structural liquidity of the underlying assets, which are their depth and breadth in their respective markets. The big risk is embedded in the word "exit" whereby sudden volatility can cause havoc on a huge scale.

In its latest Global Financial Stability Report, the International Monetary Fund warns that when an unexpected market adjustment occurs in such a way it causes term premia in bond markets to revert to historic norms (for example, increasing 100 basis points) and credit risk premia to normalize (a repricing of credit risks by 100 basis points), which results in higher bond yields and therefore lower bond prices, the market value of global bond portfolios could be reduced by more than 8 percent, or $3.8 trillion, which is serious under all angles.

Of course, nobody should worry about such an event were there was not possibility of the Fed finally starting to raising rates, even if only moderately and slowly.

As Lorraine Hansberry said: "Never be afraid to sit a while and think."

Long-term investors should ask themselves: "The day such a sudden volatility spike occurs would my investment still be liquid and could I sell with the speed of a push of a button?"

Finally, over the weekend we've learned that various big banks like JP Morgan Chase, Goldman Sachs, Credit Suisse and the Bank of New York Mellon have started charging their large customers who have euro deposits with them. HSBC Holdings noted it would soon start charging its customers who have more than 10 million euros (about $13 million) in deposits with them. I can't imagine how that could be supportive for the euro in the short to medium term. That doesn't mean that in the short term we could see a bounce in the euro and a downward move in the dollar as I noted about a month ago.

Yes, try to be prepared for what could come, as these are highly unusual times.

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Long-term investors should ask themselves: "The day such a sudden volatility spike occurs would my investment still be liquid and could I sell with the speed of a push of a button?"
China, GDP, Waldorf, euro
Tuesday, 21 October 2014 09:42 AM
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