Bartering for the Dow

The Dow Jones Industrial Average crossed the psychological threshold of 10,000 last week, before retreating slightly. Once again the Dow is in dollar terms at the level reached back in March 1999. On October 15, John Authers at the Financial Times, pointed out that priced in Euros or gold, the Dow has performed much more poorly. Moreover, it has drastically underperformed emerging markets, and other stock indices.

How has the Dow performed compared to oil? This chart compares the performance of the Dow in dollar terms to its performance when priced in barrels of oil from January 1999 to October 2009.

The price of the Dow in oil is measured by dividing the daily closing level by the daily spot price of oil (WTI). The first day of trading in January 1999, the Dow closed at 9,184 and spot price of oil was just over $12. October 16, 2009, the Dow closed at 9,995, or less than 10% higher than January 1999. In contrast, that same day oil closed at just over $78, 6.5 times the January 1999 price. Measured in oil, the Dow is down 81% since 1999.

Although we don’t literally call our stockbrokers in order to barter oil for stocks, it is important to consider the price movements of equities relative to other assets. In general, the value of equities has declined significantly relative to raw materials, oil being the most salient example. The weak dollar has been closely linked to the U.S. stock market rally, mainly since both reflect increased risk appetite (a weak dollar improves earnings for global companies as well). Yet a weak dollar also has been fueling a further surge in dollar priced commodities. A lot of oil producing countries are very concerned about the value of their dollar reserves. Furthermore, supply concerns will continue to make the world subject to oil price shocks. Whatever impacts animal spirits have on the near term stock market movements, there is little reason to believe that the value of U.S. based equities will perform well when compared to oil, or any other raw material.

Of course the Dow is a bit primitive as an index, especially when you consider that in it, companies are weighted by stock price, rather than market capitalization. Moreover, this analysis doesn’t include the reinvestment of dividends. Nonetheless, in price terms, it is clear that equities have underperformed oil. For a deep discussion of flaws in and alternatives to the Dow click here.

Aussie Aussie Aussie(Oi Oi Oi)

Hat tip to the Australian Central Bank for being the first in the G-20 to make a clear post crisis move away from currency debasement*. Indeed when Central Bank Governor Glenn Stevens boosted the Australian target overnight cash rate by 25 basis points to 3.25%, no one should have been particularly surprised. Yet the markets appeared to react strongly anyways. The Aussie dollar is up against the majors, and gold is way up.

The Australian economy is in a far better situation than the rest of the G-20. Inflation is a bigger problem than contraction. Compared to America, Australia didn't even really have a housing crisis. Australia has benefited from a strong trading relationship with China(Rio Tinto problems notwithstanding), booming exports to Asia and the world of coal, iron ore, alumina, meat and wool. Domestic water scarcity and environmental problems remain a major downside risk, but with population so sparse, this problem seems minor compared to the rest of the world.

The currency trends over the last couple months hints at the strength of the Australian economy, as well as the fact that the rate move was widely anticipated. This chart, highlighting the pound/aussie exchange rate, is ironic when you consider the fact that Australia started as a British penal colony:




We're all gold bugs now

Not quite. Gold reached$1,045 Tuesday, but anyone who got in too late and overleveraged will likely feel a bit of pain as profit taking drives a pull back during the Asian Wednesday morning. That being said, going short gold at anytime leaves one incredibly vulnerable to a low probability high impact tragedy that leads to widespread panic. Take the spike in gold post 9/11 for example. Moreover, even if China scales back on buying raw materials, the Federal Reserve's loose policies will in the long term ceteris paribus make expensive anything tangible that is priced in dollars, even without a global conspiracy to "ditch the dollar."



*Israel raised rates in August, but it is not a member of the G-20

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中国人吃鸡爪子，保护世界的贸易？

美国和中国最近有贸易的矛盾。美国总统提高中国轮胎 的关税，气死中国。 结果中国威胁说提高鸡爪子关税。 不过这个对中国人不好。很多很喜欢吃鸡爪子。所以，中国的政府有可能 不这样做，今天纽约时报说。可是中国大概高汽车的关税来报复。 这个可能帮助中国的汽车公司。

美国报纸的新闻

从这个星期之后，我每个星期把特别有意思的英文新闻，总结在这个博客. 欢迎您的评论.

• 华尔街日报 开玩笑， 说中国财政部祝贺本伯南克。 中国财政部给伯南克的写信（其实华尔街日报写的）。 祝贺他, 因为美国总统再次统任命他。 感谢他保护中国房利美公司的投资（他甚至用美国人的钱保护中国政府的投资）。 不过也比较担心，害怕他的政策会导致通货膨胀. 中国毕竟在美国投资很多钱。 有的时候为了说明事情，开玩笑 就是最好的方法。
• 这个星期美金下跌。 有可能世界的投资家认为美国没有以前的安全。 好像中国人最近买很多黄金

Two reasons why the August rally in US equities will end badly

1.) Corporate executives and directors sold about 30 times as much stock as they bought in August. Perhaps, they sold from a position of knowledge advantage. Meanwhile, sheepish mutual funds and retail investors gobbled up rising shares. Of course, these shares are typically part of compensation along with a salary, and executives sell them for cash needs, Yet, in a typical month the ratio is 7:1. Certainly, executive's personal cash needs don't explain the entire gap: they likely recognize the overbought conditions of their own companies. But the fact that corporate executives were scrambling for cash, (perhaps to cover mortgage debt?), still feeds into the second reason that the equity rally won't last.

2.)The fundamentals of the U.S. economy are still dreadfully weak.

In July Non-Farm Payrolls declined by 247,000. Consensus estimate among economists is for a loss of 222,000 in August, with data to be released this coming Friday. Non-Farm payrolls is highly subject to statistical aberration, given that it is released monthly, but the trend of job losses is clear. How are the unemployed going to fuel a rebound?

If Non-Farm payrolls surprises to the positive(i.e. less than 222,000 jobs lost in August), the rally could revive temporarily, but this will just make the pigs fatter for the slaughter. The talk of "positive second derivatives" is absurd, even if you have full faith in the statistics. The trajectory of the economy is not entirely linear. One a couple months of slightly less negative data does not make a recovery. As it is the economy will need to add a lot of jobs before consumers can get back on track to boosting the economy.

If non farm payrolls surprise to the negative, short sellers will have a heyday before the long weekend. In July, nearly 5 million U.S. citizens had been looking, but unable to find work for more than 27 weeks. As unemployment insurance runs out, they will be no help in the recovery.

For the speculators: Deep out of the money puts on the Dow and the S&P, or major other indices not just in the U.S. but globally. According to the Financial times, put/call ratios on the S&P have already spiked upwards, indicating a rising bear. Moreover, futures on the VIX, a measure of volatility, or investor fear, have also spiked.

For the highly risk adverse: don't listen when your advisers tell you to take the money out from under your mattress.

How will China deal with its bubble?

Its no secret that China's hitherto successful stimulus has gone mainly into domestic equity and property markets. Currently little is going into the real economy, in a bubble story captured in Tuesday's Financial Times( a more extreme version of this thesis was best articulated at the Contrarian Edge). While a bursting of these asset price bubbles will certainly hurt, but it need not necessarily be the death of the Chinese growth story, as many people are begining to suggest.

Chinese policy makers have probably done the best they could do in response to the financial crisis. What they do next will determine how much longer the good news can continue.

There is solid evidence of Chinese stockpiling of critical raw materials such as copper and oil, as a hedge against the dollar. These stockpiles, largely held by state owned enterprises, must be released into the real economy. With taxi drivers speculating in stocks and flipping condos today, be prepared for a hard landing in Chinese stocks and real estate. The Communist party wants to maintain its power, but releasing resources to the real economy, especially the private sector will the be the key to a sustained, genuine recovery.

>Expect China to continue to seek to provide advantages to domestic users or raw materials, even as they face a challenge at the WTO. The current WTO challenge, from the US and EU captures only the tip of the iceberg. Many more subtle strategies will be employed in the near future. Again, if China is gives too much advantage to the state owned sector, than the long run outcome will be much less sanguine. However if they are succesful at giving advantages to domestic entrepenuers, without facing serious multilateral retaliation, than China may get out of this situation in front.

Forex: The Paradox of Safe-Haven Status

In the short term, in a global environment made dangerous partially by U.S. economic problems, the U.S. dollar is a safe haven for the risk averse investors worldwide

On the face of it it, this may sound absurd and indeed many anticipate a dollar crisis, and may be right in the long term. Yet on Monday, in a scenario that will likely repeat itself, there was bullish action in the dollar, as Wall Street was bad but emerging markets were far worse. The dollar is living up to its safe haven status as bad macro news in emerging markets boosts it. The dollar continues to rise, especially every time a bit of air is let out of the asset price bubble in the Shanghai and Hong Kong stock markets.

Take the EUR/USD and GBP/USD for examples. EUR/USD was over $1.45 in early August, and the GBP/USD peaked at just over over $1.70. The dollar strengthened, until last week, when better than expected growth data out of Germany and France, combined with poor retail sales out of the U.S. drove the EUR/USD near to $1.43. Yet on Monday EUR/USD was testing resistance below $1.41 following a rough day for Asian equities, and better than expected U.S. manufacturing data. Likewise GBP/USD is now slightly above $1.63. Of course the Pound has its own set of problems similar to the USD. Among the major currencies, only the Yen outshone the dollar on Monday.


Year to date Shanghai is up 57 % and the Hang Seng is up about 40 %. Yet the markets were down 6% and 3.6% respectively on Monday. This capital isn't fleeing to EU or UK assets(or IMF special drawing rights), just yet. A lot of this capital is moving into dollar based assets such as Treasuries. Even though the U.S. dollar has its problems, this puts upward pressure on the dollar, the so called safe haven.

The fiscal position of the U.S. government is beyond dismal, and the U.S. economy will likely lag behind the rest of the world in terms of growth. These two key factors point to a long run dollar decline, the occasional American green shoot notwithstanding. Yet the dollar remains the main global reserve and transactional currency. In the absence of fully developed viable alternatives, the dollar will continue to get a short run boost each time there is a bad day in emerging markets.

Small part of tire market. Big headache for Obama

"We gonna roll
'til the wheels fall off, y'all muh'f--kers check the tires"
-Jay Z

Its not unusual for unions and business groups to be lobbying on opposite sides of an international trade issue. But the industry cross cutting nuances of a current trade dispute involving Chinese tires are about to make things awkward for the Obama administration, who will ultimately make a decision with potentially broad implications for Sino-American business ties. Anyone who makes money off or competes with those that move goods across borders had best pay attention.

The Rundown

Section 421 is referred to as a China-specific safeguard. In a nutshell, it allows U.S. domestic industry to get relief from a sudden flood of Chinese imports that materially damage their interests. The U.S. International Trade Commission(ITC), a quasi judicial federal agency, is responsible for determining if this has occurred, after formal testimony from both sides. Unlike with Anti-Dumping, there is no need to prove goods were sold below cost. Unlike with Countervailing Duties, there is no need to prove that the foreign operation was government subsidized.

When the ITC rules affirmative on a section 421 case, they recommend a remedy, usually large tariff steadily decreasing over a few years, so that the American industry is able to adjust to a sudden flood of Chinese imports. However, unlike Anti-Dumping and Countervailing Duties, where the President is officially powerless to intervene, Section 421 cases have an important executive component. The president can choose to implement the ITC recommendation, implement an alternative, or if he believes interference isn't in the national interest, he can take no action. In this case, the president must choose by September 17 if he wants to follow the ITC recommendation for a 50% tariff on the Chinese tires. He will receive a confidential recommendation from the U.S. Trade Representative(USTR) Industry groups will have an opportunity to openly express their viewpoints before the USTR this Friday, August 7.

Typically the cases involve industrial, rather than consumer goods, so you have different American businesses arguing on different sides of the case. One uses the goods as an input and wants to buy them cheaply; one wants to sell them in the U.S. but can't compete with Chinese imports. This case also has its own special characteristics.

The motley groups of representatives seeking to influence the executive decision on this case fall into two camps. On one side is the Union group which actually filed the case. Opposing the case are tire users, and various other groups. What is also remarkable is that an industry group that produces tires also opposes the action, because of fear of disruption (and probable connections with China. The unions argue jobs are at stake. The opposition argues that the Chinese products mainly serve the low quality end of the market, which isn’t generally served by U.S. producers, and is a very small portion of the applicable market. Chinese imports would be quickly replaced by imports from other countries, either because of genuinely new market entrants, altered production chains, or clever rules of origin marking. This has happened before with import restrictions, notably in the case of fish. Perhaps the Unions know this won't make a huge impact on U.S. Tires, and merely are giving a shot across the bow, in hopes of scaring off some Chinese producers hoping to enter union heavy industries.

The Hook

President Bush chose to take no action in each of the Section 421 cases that came to his desk. That pleased China, but also irritated a key constituency in the U.S.

Obama campaigned promising to please that key constituency.

Labor unions and domestic manufacturers with limited foreign sourcing have been big democratic backers. Yet on the other hand, Obama doesn't want to derail hopes of making a mark on the Sino-American economic relationship by upsetting his counterparts over such a small part of the economy. Chinese officials have already expressed concern about the case. If he implements the ITC decision(technically he could implement an even more severe option too), a lot of importers with Chinese connections will be on the lookout, wondering if their products will be the next target. If he chooses to take no action, or implement a lighter solution, many of his key constituents will question his promise to enforce trade laws, in the face of diplomatic difficulty and business oposition.

Importers: Front load your inventories to get in ahead of any possible duty spike.

Unions: Real life is more complex than a campaign promise. Be careful what you wish for.