Home' Trinidad and Tobago Guardian : June 27th 2013 Contents There is the old Chinese expres-
sion of yin and yang. Yin refers
to the bright and sunny side
and yang speaks to the shady
(darker) side. Both are consid-
ered to go hand in hand and
one cannot exist without the other.
The stock markets of the world are in a bit
of a tailspin at the time of writing and, of
course, the focus is on the actions or potential
actions of the US Federal Reserve. However,
there is another duel playing out and that
speaks to the interaction between Japan and
Chin, hence the headline.
However, before getting into that, here is
my take on last week s announcement by the
US Fed. The US Federal Reserve will taper its
bond buying programme unless it needs to
continue buying in which case it will continue
to buy. In other words, they will stop their
asset purchases when they think they need to
and continue until they need to.
That may not sound like a big deal and,
from my perspective, it isn t. However, the
stock, bond and commodity markets all reacted
negatively following the Fed announcement.
The fixation was on the assumption that the
Fed is on course to taper its bond-buying pro-
gramme in 2014. Apparently, the fact that an
explicit timeline was given spooked the market,
which then tried to front run the crowded
trade by selling bonds.
For reference, the yield on the ten-year US
treasury was 1.66 on April 22, 2013. Two
months later, we are above 2.50 per cent intra-
day and over a 52-week period the market has
seen rates move from 1.39 to 2.50 per cent.
These are significant moves and have the
potential to create a fair amount of market
The first lesson in all of this is, of course,
don t panic simply because fundamentals don t
move by so much so quickly, only market sen-
timent does. If, therefore, you were investing
on the basis of market fundamentals as
opposed to trying to time the market, then
there is little to worry about.
Recognise that markets don t ever move up
in a straight line and a stock market rally that
began in November 2012 and went straight
up from there in the process taking out multi-
year highs was always due for a correction.
This we are now getting.
In addition, the bond moves, while discon-
certing, would have probably just reset the
range for the ten-year treasury yield from 1.75
to 2.25 to a new range of around 2.00 to 2.60
per cent. The wider range is due to the expec-
tation of increased volatility from here on.
Appreciate that there is still some measure of
overlap in the two ranges provided further
emphasising the need to avoid panic selling.
A key part of this investment thesis is that
the US Fed is probably too optimistic as they
have consistently been in the past about the
outlook for the US economy. The Fed view
is that the economy will overcome the fiscal
headwinds and could be reaching into 3.0
per cent growth territory.
There is the light from a recovery in home
prices and more buoyant construction activity
that adds to gross domestic product. These
positives are expected to continue to bring
the employment rate down and the projection
is for an unemployment rate with a six handle
during the course of next year.
This is a view that must be respected and
could be close to the consensus. However,
my caution is to not get too carried away in
the event that the Fed is once again being
too optimistic. Appreciate that if growth
begins to taper off the Fed can ill-afford to
also taper its bond purchase programme as
to do otherwise will result in a back up in
yields, which will stymie the nascent housing
Mortgage rates have jumped quite sharply
and with it the cost of servicing a mortgage.
The knock-on is less disposable income for
consumers. Also, with inflation contained, it
is probably more practical to err on the side
of adopting a more dovish stance for longer
so as not to pull the rug from under the
My biggest concern is that since the last
recession in the US, we are quite some way
into the business cycle. Revenue growth has
slowed during the last round of earnings
announcements and the quality of earnings
has deteriorated somewhat. The stock market
performance of the recent past has on a fun-
damental basis been, in part, due to share
buybacks and dividends as companies lack
opportunities to deploy cash and seek ways
to return value to shareholders.
The glimmer on this score is the fact that
commodity prices have pulled back sharply
and so margins on companies with significant
commodity inputs should improve. However,
the point remains that the current business
cycle is long in the tooth and there is the
probability of recession or reduced growth
over the next couple of years. The Fed has
in the past been able to extend the length of
the businesses cycle, but this would require
them continuing to play an active role in the
markets going forward.
The other point is that commodities are
falling for a reason and that ostensibly is due
to a fall off in global demand with overall
reduced prospects for global growth to the
end of the year. While we are facing another
global situation at this time, let s be clear it s
a situation rather than a crisis.
As already discussed, the US stock markets
were down heavily on consecutive days before
calming a bit last Friday. In Europe, stocks
closed down for the fifth consecutive week.
The last time this happened was in 2011 dur-
ing the days when the Euro crisis loomed
Yet the challenges are not only in the US
and Europe, this is a global issue because
markets are interconnected. A slowdown in
Asia, starting around February of this year,
was followed by challenges in the big emerging
market economies of Brazil and China.
In addition, Japan launched an unprece-
dented experiment to pull itself out of its
twenty plus years of deflation but this has
also impacted other countries.
The ingredients in the pot are now being
stirred by a sniff of rising interest rates and
the big question is what s next.
So let s come off the beaten track and focus
on Japan. I have long held the view that Japan
will be the catalyst for the next stage of global
economic challenges. Japan s ambitious plan
of quantitative easing, combined with struc-
tural reforms and economic stimulus, have
also been documented here. The result was
a falling yen and a rising stock market (Nikkei).
However, the yen was unable to break
through resistance at the 100 level against
the US dollar and began strengthening again.
This caused a sell off in the Nikkei (the Japan-
ese stock market index) around the beginning
In the middle of all of this is China. Cheap
money in US$ and Japanese yen made its
way into China for the purchase of Chinese
assets. This is another form of the carry trade.
When the Yen started to strengthen, followed
by interest rate increases in the US and with
it US$ strengthening, these trades had to be
This sharp withdrawal of funds from China
as pushed up short-term lending rates in
China to record levels, and an unwillingness
by the central authorities to act quickly, sug-
gests that monetary policy will not be used
to the same level to promote growth.
Slower growth in China ultimately means
less demand for commodities and this has
negatively impacted numerous emerging mar-
ket economies, especially those with a com-
modity base. The stresses in Brazil are but
one example of the knock-on effect of these
shifts, Turkey could very well be another.
A global slowdown is probably the worse
thing that can happen to Japan with its aging
population and export-lead economic model.
In other words, things can come full circle
The bottom line is that there is enough to
cause concern but no reason yet to panic.
Further, this is not just about the US Fed,
but rather a global situation. If a global slow-
down takes root, the US Fed will be hard-
pressed to scale back as the US will also begin
to slow. The Fed is forecasting yin, but there
is a bit more yang in the mix than we realise.
Ian Narine is a broker registered with the
Securities and Exchange Commission and
can be contacted at: email@example.com
B20 | COMMENTARY
BUSINESS GUARDIAN www.guardian.co.tt JUNE 2013 • WEEK FOUR
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