"Macro" Musings

[ni-co]

I am negative on China mid-term. They have taken on too much debt and they have to delever. I don't think that even the Chinese government would argue with that. Long term I understand your bullish arguments though I'd think there's quite a difference between arguing with work ethics and with potential productivity gains. But what you're talking about is the very long term (20+ years). I'd be very cautious to conclude from Dalio's arguments that China is going to be great for the next 10 years. You never know but I think the probability isn't high.

 

Every debt bubble is slightly different. Brazil has great potential, too and been having it for 50 years but that didn't keep them from having a lost decade. Debt expansion and contraction are very powerful and far more important than productivity gains when you're planning for the shorter to midterm. I don't think that Dalio would argue otherwise.

[rb]

I am negative on China mid-term. They have taken on too much debt and they have to delever. I don't think that even the Chinese government would argue with that. Long term I understand your bullish arguments though I'd think there's quite a difference between arguing with work ethics and with potential productivity gains. But what you're talking about is the very long term (20+ years). I'd be very cautious to conclude from Dalio's arguments that China is going to be great for the next 10 years. You never know but I think the probability isn't high.

 

Every debt bubble is slightly different. Brazil has great potential, too and been having it for 50 years but that didn't keep them from having a lost decade. Debt expansion and contraction are very powerful and far more important than productivity gains when you're planning for the shorter to midterm. I don't think that Dalio would argue otherwise.

I agree that there's a lot of debt sloshing around in China and they may hit a deleveraging cycle. Over there it should be a lot easier since they have what? 13-14% nominal growth? Also the gov't may step in, setup a bad bank and do essentially debt forgiveness. That would make it a lot easier for the economy. They've done that in the past and it worked well.

 

Not saying that China won't hit any bumps in the road. But I don't see why that would be such a big deal. The developed economies have had a lot of recessions. It's normal. Nobody said that US or Germany economies are finished because they had a recession. I don't see why it should be different in China's case.

 

rb

 

[ni-co]

They've done that in the past and it worked well.

 

Not saying that China won't hit any bumps in the road. But I don't see why that would be such a big deal. The developed economies have had a lot of recessions. It's normal.

 

Yeah, I think this is exactly the question: Are we facing a recession? Or a secular global deleveraging process? I'd agree with you if we were facing a recession but I think it's the latter and we have been facing it since 2008. In 2009, China was able to delay its impact but they thought the rest of the world would have recovered by now. Well, it didn't. I think this is a huge worldwide problem – and now China has to face it, too.

 

The fears people had back in 2009? They weren't irrational. If you think this process through logically you'll come to a point where you have to ask yourself what the markets are going to do when they discover that central banks can only solve liquidity problems but they can't create demand out of thin air (once credit expansion isn't an option anymore). Then what? I think that people like Druckenmiller, Dalio, Bass are absolutely spot on here – Soros has been worrying about it since the 1980s. Do you know any great global macro manager not worrying about this today? I can't think of a single one.

[petec]

Good discussion everyone.

 

Yada, for what it's worth I think you're missing a few things:

 

1. China's potential in the long run is clearly good for the reasons you have outlined.  But timing can be a bitch.  They have taken on a staggering amount of debt over the last 7 years, borrowing to build stuff they don't need (there's a lot of evidence of awful capital allocation).  Even if that stuff lasts until it is needed (which can be questioned given what I've heard about build quality), the key thing is when the debt comes due vs. when GDP is created to pay for it.  And that seldom works out well when a lot of the debt has gone into non-productive investments (i.e. ones that don't create a lot of GDP except during the building phase).  If the debt comes due before the GDP is created you might get a crisis, regardless of the long term potential.

 

2. You make the assumption that China is viewed as a good place for Western firms to do business.  It isn't.  It's viewed as a very dangerous place to put IP, and arguably to put capital, because there is not enough rule of law when it comes to respecting foreign investments.  Firms have had to go there because of the growth, but governance is going to be a real problem for them if growth does slow and the psychology of "we have to be in China" changes.  There are plenty of places in the world that have very cheap labour (some of it intelligent and hardworking) but which attract no investment because of poor governance.

 

3. You highlight the key weakness in your argument yourself.  China's main competition is not the West (where some jobs will always stay because they have to be done there, or because the level of education is higher), but the other emerging markets.  And the populations there are huuuuuge.  There are lots of places to build a factory, many of them closer to Western markets and with better governance.  That's potentially a real problem for China, especially since its labour rates have been rising sharply in the last few years and are no longer particularly cheap vs. these competitors.

 

3a. Demographics matter, and China's working age population peaked in 2012 and is projected to fall ~8% over the next 25 years.  That's a key input for growth.  India is projected to grow by >20% over the next 25 years and the US by about 7%.

 

4. You've failed to address the key Pettis point that for the last 7 years China's growth has not been labour intensive.  Instead it has been driven by debt-fuelled investment, which in turn has been driven by suppressing household incomes (to make it cheaper for firms to borrow and do business).  It is the potential bursting of that bubble over the next 5 years that is the issue, not whether China's labour pool affords it an advantage on a 30-year view.

 

4a. Related to this: China's GDP is 50% investment and that is the fastest growing part.  It's 33% consumption and that is growing slower.  Basic maths shows you that if investment slows a lot, which is a necessity given the debt dynamics and is also government policy, consumption has to rise very fast to prevent a sharp slowdown in GDP.  They might succeed in rebalancing gently, or they might not.  This has nothing to do with labour rates and everything to do with the fact that Chinese GDP growth has been driven by borrowing money to build an excess of stuff. 

 

5. You say current accounts and capital flows aren't a good indicator.  Pettis makes a good case that they have been, in the past.  He cites several examples of very rapid unbalanced growth, with all sorts of characteristics including unbalanced capital flows that look like China does today (but generally less extreme), and none have ended well.  In other words, his indicators look to me like good predictors of the future.  Your one (relative labour rates) is also a good one when governance is good and there doesn't seem to be a debt bubble, but I'm not sure it can overcome poor governance and a debt bubble in the medium term.

 

That said I think the difference in our view is largely timescale.  I'll be a little surprised if China doesn't grow well on say a 20 year view.  I just think there might be a severe bump on the road, driven by the inability to repay debt.

 

What I would be really interested to see is if you would make your case on Pettis' blog.  He's very active in replying and it might generate a good discussion.

 

Pete

[Liberty]

http://scottgrannis.blogspot.ca/2015/02/the-65-year-trends-in-equity-prices.html

[Borgesian]

Latest from Michael Pettis: http://blog.mpettis.com/2015/02/when-do-we-decide-that-europe-must-restructure-much-of-its-debt/

[Libs]

Latest from Michael Pettis: http://blog.mpettis.com/2015/02/when-do-we-decide-that-europe-must-restructure-much-of-its-debt/

 

Terrific. Thanks for posting.

[indythinker85]

http://www.valuewalk.com/2015/02/baupost-group-q4-14-letter/

 

http://www.bloomberg.com/news/articles/2015-02-13/baupost-sifted-through-energy-carnage-as-bargains-rare

[giofranchi]

Martin Capital Management 2014 Annual Letter

 

 

Gio

Martin-Capital-Management-2014AL.pdf

[Valuebo]

This euro devaluation versus the USD is brutal. If this and cheaper oil don't boost economic growth in the EU, I don't know what will.

 

And just getting more brutal. Although my European holdings have done phenomenally well, I wish I had more in USD.  ;)

 

Remember when the most bearish EUR/USD analysts predicted the pair to be at 1.16 by end of 2016? That was just a few months ago. Do they now throw in the towel and stop predicting market movement? Of course not! Let's act as if nothing happened and predict 0.85. When they get there they can make another random prediction!

[Jurgis]

This euro devaluation versus the USD is brutal. If this and cheaper oil don't boost economic growth in the EU, I don't know what will.

 

And just getting more brutal. Although my European holdings have done phenomenally well, I wish I had more in USD.  ;)

 

Yeah, the board members in EU and Canada have huge performance tailwinds if they hold US securities.

[giofranchi]

http://www.viewfromtheblueridge.com/2015/03/12/nowhere-to-run/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+viewfromtheblueridge%2FJkgK+%28The+View+from+the+Blue+Ridge%29

 

 

Gio

[Guest]

has anyone seen research on how accurate GMO's projections are?

[peter1234]

has anyone seen research on how accurate GMO's projections are?

 

Their 7 year projections were spot on for a long period. I think the Economist once looked at them. Granthams bubble research is pretty good too.

However, his other predictions of what happens in the next months to year does not seem to be better than other observers.

[wisdom]

http://business.financialpost.com/2015/03/13/the-world-must-prepare-for-its-dollar-binge-punishment-and-it-wont-be-pretty/

 

Write up on global debt in USD and it's implications.

[KinAlberta]

has anyone seen research on how accurate GMO's projections are?

 

Their 7 year projections were spot on for a long period. I think the Economist once looked at them. Granthams bubble research is pretty good too.

However, his other predictions of what happens in the next months to year does not seem to be better than other observers.

 

Yeah the long term prediction assessments I've seen over the years have often been shown to be quite good - not perfect of course.  As for his host term predictions, I don't know, but one thing, in about late 2007 to mid 2008 I recall him essentially saying: run for the hills.  That was pretty accurate.  Worst case would have been some opportunity lost had the market turned back upwards but best case, as it actually turned out too, was to sell pretty much everything and wait for an opportunity.  I think he even got the bottom fairly right too. Maybe someone could dig back to verify.

 

 

 

 

BTW, I created the Jeremy Grantham page on Wikipedia, thinking he didn't get the attention he deserved.  It would be great to post more info on it in terms of his performance, quotes, etc.

 

 

In GMO's April 2010 Quarterly Letter Grantham spoke to the tendency for all bubbles to revert to the mean saying:

 

“ For the record, I wrote an article for Fortune published in September 2007 that referred to three “near certainties”: profit margins would come down, the housing market would break, and the risk-premium all over the world would widen, each with severe consequences. You can perhaps only have that degree of confidence if you have been to the history books as much as we have and looked at every bubble and every bust. We have found that there are no exceptions. We are up to 34 completed bubbles. Every single one of them has broken all the way back to the trend that existed prior to the bubble forming, which is a very tough standard. So it’s simply illogical to give up the really high probabilities involved at the asset class level. All the data errors that frighten us all at the individual stock level are washed away at these great aggregations. It’s simply more reliable, higher-quality data.[8] ”

 

 

In his Fall 2008 GMO letter, Grantham commented on the underlying causes of the world credit crisis:

 

“ I ask myself, ‘Why is it that several dozen people saw this crisis coming for years?’ I described it as being like watching a train wreck in very slow motion. It seemed so inevitable and so merciless, and yet the bosses of Merrill Lynch and Citi and even U.S. Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke — none of them seemed to see it coming.

I have a theory that people who find themselves running major-league companies are real organization-management types who focus on what they are doing this quarter or this annual budget. They are somewhat impatient, and focused on the present. Seeing these things requires more people with a historical perspective who are more thoughtful and more right-brained — but we end up with an army of left-brained immediate doers.

 

So it’s more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history, they are always going to miss it. And the three or four-dozen-odd characters screaming about it are always going to be ignored. . . .

 

So we kept putting organization people — people who can influence and persuade and cajole — into top jobs that once-in-a-blue-moon take great creativity and historical insight. But they don’t have those skills.[9]

 

 

http://en.wikipedia.org/wiki/Jeremy_Grantham

[vinod1]

has anyone seen research on how accurate GMO's projections are?

 

I have been following GMO very closely since around 2001. They used to issue a much more detailed forecasts by sub-asset classes at that time. Even one of the foremost efficient market gurus and who I respect a great deal, William Bernstein, studied GMO methodology and commented that GMO does these forecasts in just about the best way that is humanely possible. My own experience also supports this.

 

In 1999, they issued a 10 year forecast for 11 different asset classes (small value, large cap value, REIT, etc.) and they nearly got everything right.

 

Vinod

[vinod1]

GMO forcast attached.

 

Vinod

GMO.pdf

[original mungerville]

My experience following GMO is that they are accurate over the long-term. Their 7-10 years forecasts are pretty damn good. They, like all of us, have trouble predicting when the markets will turn... but they don't try and do that with their 7-year forecast.

 

Its pretty reliable I believe.

[Guest]

awesome. thanks for the additional insights about GMO guys.

 

Here is some other points:

 

http://www.cxoadvisory.com/3200/individual-gurus/jeremy-grantham/

 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2446546

[Jurgis]

http://www.cxoadvisory.com/3200/individual-gurus/jeremy-grantham/

 

That's Jeremy Grantham I remember: if you listened to him, you would not have made money for the last 20 years. Except for two crashes, perhaps.

[original mungerville]

http://www.cxoadvisory.com/3200/individual-gurus/jeremy-grantham/

 

That's Jeremy Grantham I remember: if you listened to him, you would not have made money for the last 20 years. Except for two crashes, perhaps.

 

Wrong, if you listened to his long-term views on the year 7-10 predicted returns of various assets over the past 15 years,  you would have made money. Like I said, he like others, has trouble picking when the turns will happen - otherwise, he'd be as rich as Midas!

 

That stupid analysis does not look at the long-term predictions by asset class made in his asset class forecast, it just uses interview quotes where he is asked to basically guess which way the market might go in the near-term. He answers, but that is just not what he does in his asset class forecast which has a 7-10 year horizon and is usually quite accurate.

[Jurgis]

Wrong, if you listened to his long-term views on the year 7-10 predicted returns of various assets over the past 15 years,  you would have made money.

 

Pray tell how you made money from listening to his "7-10 predicted returns of various assets over the past 15 years". Some facts please.

 

Edit: question withdrawn as not quantifyably answerable.

[philly value]

Wrong, if you listened to his long-term views on the year 7-10 predicted returns of various assets over the past 15 years,  you would have made money.

 

Pray tell how you made money from listening to his "7-10 predicted returns of various assets over the past 15 years". Some facts please.

 

I'm not sure about the interim predictions, but if you followed their forecasts from late 90s you would have bought REITs and emerging market equities and done very well, avoiding the S&P which they predicted would have a negative return for the decade. Their return projections in the depths of the recent crisis would have led you to re enter the U.S equity market.

[Jurgis]

Wrong, if you listened to his long-term views on the year 7-10 predicted returns of various assets over the past 15 years,  you would have made money.

 

Pray tell how you made money from listening to his "7-10 predicted returns of various assets over the past 15 years". Some facts please.

 

I'm not sure about the interim predictions, but if you followed their forecasts from late 90s you would have bought REITs and emerging market equities and done very well, avoiding the S&P which they predicted would have a negative return for the decade. Their return projections in the depths of the recent crisis would have led you to re enter the U.S equity market.

 

I am sorry, I think you are data mining here. But I agree that it's a tough question to ask since everyone will data mine to support their opinion. I withdraw the question.  8)

 

Peace. :)