Posts Tagged ‘recession’

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Closing in for the kill in value investing

Monday, January 3rd, 2011

In our previous two articles, Choosing the businesses with strong economics- Part 1: avoiding poor economics businesses and Choosing the businesses with strong economics- Part 2: finding durable competitive advantaged businesses, you have learnt about which businesses to avoid and which ones to look out for as your investment candidates. Once you have identified such businesses, the next question is, when do you make a move to invest in them?

First, you need to have some idea how much that business is worth. Our previous articles, Measuring the value of an investment and Effects of inflation on value of investment will give the mathematical explanations on how to value a business. But do not confuse mathematical precision with accuracy. As we said before in Confusion between precision & accuracy,

As the above-mentioned analogy shows, precisely wrong numbers are useless. If we use them, then the quality of our investing decision will degrade considerably.

For this reason, it is better to be vaguely right than to be precisely wrong.

Second, you must remember this: never ever pay for more than what the business is worth. In fact, it is advisable that the price you pay be of a certain margin (say 15%) below its worth. This is to give you a margin of safety against errors in judgement.

The next step is to wait patiently, stalking the business like a hunter. Eventually, bad news will strike the business, revealing the changes that will occur. Then the stock market will typically overreact, pulling the stock price to a level that is far below what it is worth. That will be the time to strike. The stock market overreacts because it is not rational and suffers the common mental pitfalls that ail every human. To be a successful investor, you need to be more rational than the market collectively. We recommend that you familiarise yourself with the common mental pitfalls as explained in our guide, Common mental pitfalls that leads you astray and Why are the majority so wrong at the same time and in the same ways?.

However, this step is the trickiest one and errors in judgement are most likely to be made. Bad news comes in two flavours:

  1. Changes to the business are temporary and therefore, a recovery will eventuate in due time.
  2. Changes to the business are permanent and therefore, there will be no recovery.

Thus, you have to discern the nature of the changes, understanding whether the context of the underlying trends in which the business changes occur is secular or cyclical (see Understanding secular vs cyclical). For example, as we explained before in Should value investors be ?bullish? in a bear market?,

One value-oriented stock research (which we will not name) believes that this current bear market will be like any other ?typical? bear market in the past- the downturn will last only 12 to 18 months. In other words, their position is that this coming recession will only be a V-shape or U-shape recession (see What type of recession is coming?). If they are wrong about that (i.e. the coming recession is an L-shape one), then their current ?Buy? recommendation will be very wrong.

In short, not all bear market purchase will turn out to be astute if the timing is way too early.

This is where value investors are most likely to get wrong.

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Posted in Investor Education, Value Investing | No Comments »

Time-wasting public discussions

Thursday, November 20th, 2008

Sometimes, we despair at the kinds of politicians we have in Australia (and by extension, the rest of the liberal democratic world). Recently, the Opposition frontbencher Andrew Robb accused the government’s Treasury department of “manipulating” figures when it made a forecast of 2% economic growth. That 2% is only 0.5% more optimistic than the RBA’s forecast of 1.5%.

To us, this is just nitpicking and exaggeration for the sake of playing the role of Opposition. As a result, some time are wasted during parliment time to address this issue. Can you believe that our dear politicians are sniping at each other while the nation is facing a serious economic problem that can turn out to be a serious recession (or maybe even a depression)?

All because of different methodologies used to make forecasts.

In the days to come, there will be a lot more public discussion on whether Australia will experience two consecutive quarters of negative growth or not (called a “recession”). Again, this will be a complete waste of time and energy. The US is already facing a major economic crisis and yet, there are some resistances in calling it a ‘recession’ (technically).

Here, as investors, we don’t really care whether Australia will hit technical recession next year. As we explained before in Example of precisely inaccurate information,

The price index is a very important number. It is used to derive real GDP growth from the nominal GDP growth. From the growth (or contraction) of real GDP, we can then define when an economy is technically out of (or in) recession.

Now, if the price index is a logically invalid number (let alone accurate), then how accurate will real GDP growth figures be for capturing the growth of output of an economy? If this figure is inaccurate, then how accurate will it be for defining when an economy is technically in recession? In that case, how useful will it be to be so precise in defining the exact point for which the economy is in technical recession?

By the time it is absolutely clear that Australia will fall into recession, it is already too late to change your investment plans accordingly. In fact, the Australian stock market has already factored in a significant recession. The smart money has already pulled out of stock market and sold down the Australian dollar.

Therefore, whenever you hear from the mainstream news media about stock prices falling because of “worries” of recessions, you know straight away that such stories are not written by investors for investors. You will save yourself a lot of time by skipping such stories.

For us, we are more worried about the long-term implications of bailouts, rescues, pump-priming, printing of money and so on.

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Posted in Looking Forward | 28 Comments »

Is it time to buy stocks in times of intense fear and volatility? Part 2: Leverage position

Tuesday, October 28th, 2008

Today, we will continue from Is it time to buy stocks in times of intense fear and volatility? Part 1: Introduction. The question was:

Surely, some of these stocks are undervalued by now right? Should you buy now? Even Warren Buffett is buying.

Well, the answer will depend on your personal circumstances. More specifically, it depends on your current level of leverage.

Before we continue, we must stress again that anything on this publication should NOT be considered as personal financial advice. We are approaching the above posed question from a philosophical point of view. Thus, we will be making many assumptions, generalisations and simplifications. The point of this article is to provoke you to think about your investment decisions based on risk-reward probabilities and should not be seen as some kind of economic analysis/prediction. Now, let get back to the gist of the article…

Let’s look at one extreme scenario. Suppose you are currently very highly leveraged. Also, you are not sure what the long-term economic outcome will be. Will the future pan out to be a V, U or L shape recession (see What type of recession is coming?)? But you believe that a V-shape recession is unlikely. Between the U or L shape recession, you are not sure which one will turn out. Now, let’s work out your risk-reward outcomes for each scenario:

  • V-shape recession (unlikely): You will stand to gain immensely when the economy bounces back ‘soon.’
  • U-shape recession (more likely): You will suffer some losses for an extended period of time. But eventually, you will recover and gain.
  • L-shape recession (not so likely but possible): You will lose your entire life-savings, go bankrupt, lose your home and become destitute because of your high leverage (e.g. someone using their mortgaged home as collateral for their stock market investments).

Now, let’s suppose you are at the opposite extreme: complete absence of leverage (i.e. 100% in cash). Let’s look at your risk-reward outcomes:

  • V-shape recession (unlikely): You gain and lose nothing when the economy bounce back ‘soon.’ Relative to the highly leveraged investors, you are very much worse off.
  • U-shape recession (more likely): Compared to the very highly leveraged investors, you are better off during the downturn. Eventually when the economy recovers, you will not be too much worse off than the highly leveraged investors either.
  • L-shape recession (not so likely but possible): You will be way ahead of the highly leveraged investors.

As you look at these two scenarios, it becomes clear that for the very highly leveraged investors, they will sleep much better at night by reducing risk of catastrophic loss through the reduction of potential for gain. That means de-leveraging. For the completely un-leveraged investors (maybe a person who is 100% in cash should not be called an investor?), they increase their prospect for gain (without increasing the prospect of disaster significantly) through increasing their risk of loss. In other words, for the cashed-up investor, the reward outweighs the risks.

In today’s free-falling market conditions, it is clear that the majority of investors are de-leveraging because they want to reduce their risk. Contrarian investors should be approaching the market from the position of extremely low risk seeking towards a gradual and measured increase of risks.

What if you are one of these contrarian investors seeking to increase your risk in the stock market? Which stocks to pick? Keep in tune!

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Posted in Investor Education, Value Investing | 2 Comments »

RBA’s interest rates dilemma

Wednesday, September 3rd, 2008

Yesterday was the first time in several years that the Reserve Bank of Australia (RBA) decided to cut interest rates. As you can read from the mainstream news media, this fall in interest rates is not necessarily good news. For example, Ross Gittins from the Sydney Morning Herald said in Yippee, the bad times are back,

YOU beauty. Interest rates have been cut and happy days are here again. For good measure, we’ve even got petrol prices coming down.

Sorry, don’t be too sure about that. The Reserve Bank has cut its official interest rate only because times are getting tougher.

But our loyal readers should already know about this fact long time ago. Back in July last year (2007), when the talk in the market was still about booming asset prices and inflation, we warned in Should you purchase first home whilst asset price inflation?,

… it is prudent to arrange their finances with the assumption that interest rates are going to be in an upward trend for at least in the medium term. Having said that, it is still possible for interest rates to be cut? when the economy is hit by a threat of recession or depression…

While those heavy in debt would welcome RBA’s interest rate relief, there are still many unresolved complications. The most important thing to remember is that Australia’s price inflation problem is still not yet resolved. The RBA is forecasting rising price inflation till the end of the year at least. Normally, no central bank will cut interest rates in the face of rising prices. But this time, they have a bigger worry than rising prices- economic recession. In other words, Australia is facing stagflation (economic stagnation/downturn and rising prices) and the RBA is more worried about the ‘stag’ part of the stagflation. And they are betting that the ‘stag’ part will somehow resolve the ‘flation’ part.

But from what we can see, the RBA’s hands are tied. If they try to prevent the slowdown from turning into a rout by slashing interest rates aggressively, it is very likely that the Aussie dollar will continue its down trend. As we explained before in Falling currency and inflation,

A rapid depreciation of the Aussie dollar will result in rising price inflation for the same reasons stated above.

We do not envy the job of the RBA. It looks like Australia may be moving towards the same path as the US (see Supplying never-ending drugs till stagflation).

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Posted in Economics/Finance, Looking Forward | 2 Comments »

Will deflation win?

Thursday, August 21st, 2008

In just a few months ago, the talk in town was price inflation. Oil, food and commodity prices were rising, as we wrote Who is to blame for surging food and oil prices?. Today, the talk is different. US house prices have never stop falling. Gold, oil and base metals are falling. There is even talk about the end of the commodity boom, the end of the commodity “super-cycle.” Economic slowdown and recessions are the expectations of the market.

Long time readers of this publication should never be surprised to see this is happening. As we said back in March last year in Inflation or deflation first?,

If you have been with us long enough, you may have heard us mulling over both the threats of inflation and deflation on the global economy (see Spectre of deflation and Have we escaped from the dangers of inflation?). You may be wondering whether we are contradicting ourselves. How can both threats exist simultaneously? Since one is a general rising of prices and the other is the opposite, are they not mutually exclusive?

At this current phase of the financial crisis, we are experiencing deflation. It is reported that the US M3 money supply is currently “collapsing.” A falling money supply is the definition of deflation, for which the symptoms will be falling asset prices, which if prolonged enough, will lead to falling consumer prices. But before we go off to celebrate falling prices, remember that this is an evil type of deflation because it is the type that is associated with bad debts, bankruptcies, unemployment, falling income, bank runs and so on. The angelic type of deflation is caused by rising output and production, which is clearly not the case in the debt-addicted Western economies but more true for China with its government-forced savings.

When the US money supply shrinks, it increases in value relative to the other currencies as the US dollar gets repatriated back to make up for the dwindling supply of cash back in the US. That’s why we are witnessing a rally in the US dollar and a fall in commodity prices as there is a mad scramble to liquidate whatever assets to raise cash.

With the current legal powers, the US Federal Reserve is quite powerless to stop deflation (see Are we heading for a deflationary type of recession?). It can cut interest rates, but it cannot force people to borrow. Even at 2% Fed fund rate, the shrinking M3 money supply is proof that monetary policy is still tight (see What makes monetary policy ?loose? or ?tight??). Will the Fed continue to cut interest rates? It had already tried but failed a few months, which resulted in skyrocketing oil and gold prices. We doubt Ben Bernanke is going to try it again.

Meanwhile, the US Treasury is preparing open up the bottomless coffers of the US government to nationalise Freedie Mac and Fannie Mae, who are essentially insolvent. The question is, with the US budget deficit already in the red (plus the massive current account deficits), where is the money going to come from to do that? If a savings-less individual spend more than he/she earns, that individual is basically bankrupt. But for governments, it is a completely different story. They can make up for the shortfall by borrowing from the public by selling newly issued government bonds. As a last resort, it can sell the bonds to the Federal Reserve, which is called “monetising debt” or printing money.

Will it get that bad? It can if the deflation threatens to shock and awe the entire nation into a Greater Depression. By then, as we said before in A painful cleansing or pain avoidance at all cost?,

Even if Ben Bernanke is an Austrian economist, political pressure alone will do the job of forcing him to act otherwise. This is the Achilles? heel of democracy. The mob will scream at the Fed to bail them out by ?printing? money (i.e. pump liquidity into the economy in the form of cutting interest rates). Should the Fed refuse to comply, we can imagine the mob storming the Federal Reserve to demand the head of Ben Bernanke. Therefore, the Fed will have no choice but to acquiesce to the desire of the mob, whose aim is to avoid immediate pain as much as possible.

Therefore, as we advised before in Recipe for hyperinflation,

Therefore, watch what the US government is doing with the monetary ?rules? in its attempt to fight deflation.

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Posted in Economics/Finance, Looking Forward | 8 Comments »

Why is the RBA backflipping on interest rates?

Wednesday, August 20th, 2008

It was just a few months ago, the Reserve Bank of Australia (RBA) was very hawkish on interest rates. Its priority was to fight price inflation and with that, even approved of the banks raising their mortgage rates. It was said that if not for the mortgage rate rises, the RBA would have raised rates even more.

It seems that all of a sudden, the RBA began to hint strongly about cutting interest rates. What is going on? As this article,  The Great Interest Rate Forecast Back Flip, reported,

Indeed, the Macquarie analysts are actually concerned the sudden turnaround in RBA intention suggests it might know something about the economy we don’t. “Has the RBA’s business liaison program revealed some financial fragility in the economy that has not yet been unveiled?” while suggesting that “for this reason lower interest rates are unlikely to be the green light for growth investors might hope for”.

One thing many experts even fail to understand is that a fall in interest rates does not automatically mean a loosening monetary policy. As we explained before in What makes monetary policy ?loose? or ?tight??,

A common misperception is to assume that any rise in interest rates automatically implies a monetary tightening (and conversely for a fall in interest rates).

What had been happening is that the demand for credit in the Australian economy is decelerating very rapidly. That is, Australian households, individuals and businesses scaling back on their borrowings. When the demand for credit slows down tremendously, what was before a ‘loose’ monetary policy can become ‘tight’ all of a sudden.  If credit demand falls further, the RBA can still cut interest rates and still have ‘tight’ money. If you are confused by this, please read our earlier article, What makes monetary policy ?loose? or ?tight??.

The best way to explain this concept is to use Japan as an example. In the 1990s, Japan famously cut interest rates to zero. Yet, asset prices kept on falling for 16 years straight. That is an excellent example of deflation whereby credit became a dirty word. Even when interest rates was zero, Japan’s monetary policy was still ‘tight.’

For Australia, a rapidly decelerating credit growth is very bad news. Since a lot of Australian consumer spending is financed by the growth of credit, this will mean a severe slowdown in the Australian economy. Furthermore, rising asset prices is fuelled by exponential increase in credit. A rapid deceleration of credit growth will result in asset price deflation.

We can imagine the RBA worrying about the storm clouds gathering ahead- US is in recession, UK is going to fall into recession, Europe is stumbling into recession, Japan is feared to fall into recession, falling commodity prices, China is slowing down, etc. If the rest of the world economy is slowing down significantly, there is no way Australia can escape.

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Posted in Economics/Finance, Looking Forward | No Comments »

Refuting Michael Pascoe’s optimism about continued growth

Thursday, August 7th, 2008

As we all know, there are a lot of chatters about recessions in the Australian media recently. As always the case, there are two opposing camps of perennial optimists and committed doomsayers on this recession debate. The question is, will there be a recession in Australia?

Our answer is, a recession is not a matter of if but a matter of when. In other words, we still believe that the economy moves in cycles. We do not believe there is such a thing as ever-lasting growth forever and ever till infinity. In fact, we made the first recession call back in February 2007 in Where are we in the business cycle?:

Thus, we believe that Australia (and the US as well) is at the top of the business cycle. For investors, we have to bear in mind that we are now probably at the cyclical top. If we assume that the current trend of companies? profit growth will extend indefinitely into the future, we will be in for a nasty surprise.

Due to some quirk in human nature, it is very easy to fall into turkey thinking as we explained in Failure to understand Black Swan leads to fallacious thinking. Therefore, it is in this context that we wish to refute Michael Pascoe’s punditry on recession, Doomsayers to the fore. We have been hearing his commentary for a couple of years already and know that he had made many wrong calls in the past, including the comments he made last year about the sub-prime crisis being just a “storm in a tea-cup.” Below are our refutations on his “10 reasons for why we won’t suffer a national recession any time soon”:

The Reserve Bank has lots and lots of dry powder if it needs it. As a result of bumping up interest rates, the RBA can easily cut and cut quite dramatically if it thinks the economy is slowing too fast.

This was the same argument made by Shane Oliver, the chief economist of AMP. As we refuted Oliver’s factual error in Aussie household debt not as bad as it seems?,

[Reflation] did not work in Japan! Remember Japan?s infamous zero-interest rate monetary policy as well as massive government spending fiscal policy? Yet, deflation dogged the nation for more than 16 years. There is only one way to fight deflation and that way leads to hyperinflation (see Recipe for hyperinflation).

Central to Michael Pascoe’s idea is the belief that the pushing of the short-term overnight cash-rates levers by the RBA is a kind of do-it-all snake oil that can solve every economic malaise. But as we sarcastically put forth this question in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

Think about this: if raising interest rates is ?bad? and cutting interest rates is ?good,? then why don?t the RBA set interest rates to zero, thereby putting the economy into a path of eternal boom (plus runaway inflation)? For those who think this is a good idea, then this article will set to let you understand why this is a bad idea.

Also, as we quoted Ludwig von Mises in How will asset-driven ?growth? eventually harm the economy?,

The economists were and are still today confronted with the superstitious belief that the scarcity of factors of production could be brushed away, either entirely or at least to some extent, by increasing the amount of money in circulation and by credit expansion.

To make a final debunking of this idea, consider this present fact: the US Federal Reserve raising interest rates in baby steps from 1% to 5.25% under Alan Greenspan. Then, in reaction to the credit crisis, it began slashing interest rates quickly to 2% today. Did that solve the core of the rot in the US economy? As we explained yesterday in Would the RBA?s rate cut do any good?, a too hasty and massive cuts in interest rates will have a very negative effect on the Australian dollar, which will not be good news for the Australian economy.

Next, Michael Pascoe said,

The RBA is ready to push money at the banks if necessary. Cutting interest rates isn’t the Governor’s only option. He also is set up to lend the banks money in exchange for mortgages if liquidity gets too tight.

Well, take a look at how the US is faring right now. This step may save the banks, but it may not be good for the Australian people. Furthermore, when debt deflation takes hold, shoving money to banks will not be enough to persuade the economy to take on more debt. As we said before in What makes monetary policy ?loose? or ?tight??,

… we have to remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

Michael Pascoe said,

We’re not the US or the UK. While a couple of our banks have ‘fessed up to big write offs and provisions, they all remain fabulously profitable and their loan book is in much better shape.

We have this to say at How safe are Australian banks?.

Next, he said,

If the unemployment starts to rise uncomfortably, the government has the option of turning off or at least turning down the big immigration inflow it’s presently encouraging. Australia’s gross immigration is running at more than 300,000 people a year.

The problem is not one of over or under employment. Rather, it is the structure (or configuration) of employment. Take a read at Overproduction or mis-configuration of production?. Also, if Australia falls into serious unemployment problems, do you think migrants will still want to come here?

Next, he said,

The Federal Government has surpluses it can turn into spending if it looks like we’re heading for the recession door. Kevin Rudd wants to be Prime Minister for a lot more than one term.

If the government spends too much money too early (by turning the budget surplus into deficit), it will not solve the problems of mal-investments and mis-configuration of production in the economy. Instead, price inflation will be the main effect. Remember, at this point in time, Australia is close to full employment.

Next, he said,

The oil price could well continue to fall, providing some needed psychological relief for consumers feeling battered by prices prices and, what’s worse, the media screaming doom and gloom about oil.

Mere short-term psychological factors will not solve the basic economic problem of scarcity of factors of production and mal-investments. Take a read at our guide, What causes economic booms and busts?.

Next, he said,

The big picture hasn’t changed – Beijing still wants to see about 200 million peasants move into the cities from subsistence existences down on the farm over about 10 years. Think about the infrastructure demands for housing and moving that many people every year and you won’t be panicked into worrying too much about the United States not buying as many Chinese-made shirts and sandshoes.

And therefore demand for our resources remains strong. The surging iron ore and coal prices are yet to fully emerge from the statistical noise and be shown as the great stimulus that the terms of trade are providing.

He got this half-right. Our views on China is summarised in Crisis and the China growth story. Let’s say China’s economic growth slowed down from around 12% to say, 5%. Relative to the ailing US economy, it is still a fantastic growth rate. But relative to itself, it is a major recession. What will this do to commodity prices in the short to medium term?

Next, he said,

Remember where our economy has come from. Yes, there has been a sharp slowdown in retail sales and credit growth – but they’re coming off very high bases. And the economy overall was running at near capacity – the RBA had to make room for the resources boom impetus.

Michael Pascoe forgot that Australia’s debt level had gone too far from the mean by a far margin. The “base” that he mentioned should be the mean, which is somewhere very much lower that where it is today.

Finally, he said,

And, finally, we do learn from our mistakes. The doomsayers tend to be so busy screaming about any potential disaster that they overlook moves buy the government and RBA to counteract them. We have to give the mandarins just a little credit – the RBA certainly doesn’t want a repeat of the last recession when it was arguably a little slow to put up rates and then far to slow in cutting them.

He forgot that Australia is not an isolated economy. It is a relatively small economy that is very much inter-linked to the global financial system and is at the mercy of global macroeconomic forces. There are some factors that is totally beyond the control of the Australian government and the RBA- for example, oil prices, credit crisis, etc.

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Posted in Looking Forward, Market Observations | 3 Comments »

Is the world already in recession?

Wednesday, July 30th, 2008

The answer to that question depends on your definition of recession. Sticking to the technical definition favoured by central bankers, the world growth is just “slowing.” But as we argued in Example of precisely inaccurate information,

Now, if the price index is a logically invalid number (let alone accurate), then how accurate will real GDP growth figures be for capturing the growth of output of an economy? If this figure is inaccurate, then how accurate will it be for defining when an economy is technically in recession? In that case, how useful will it be to be so precise in defining the exact point for which the economy is in technical recession?

What about the people on the streets? In a recent interview with Marc Faber at Faber Says Fannie, Freddie Should Split Up, Not Get Aid, he said

I travel a lot as you may know. And I can tell you in the last two months I was around the world twice. Everywhere I ask how is business and business is down everywhere. Everywhere it slowed down very considerably. And it is lower than a year ago. So I suppose you can say the world is in recession already.

One of our contacts in China told us stories about factories being forced out of business due to the falling US dollar and falling US demand. Many of these factories have very low profit margins. One particular factory is currently losing money. Yet, if it closes down, it will lose even more money. Therefore, it is forced to continue production at a loss. This anecdotal evidence is consistent with the numbers and our outlook (see China?s slowdown & its implication for Australia).

What will be the worst case scenario for the world economy? As we said before in June 2007 at Epic, unprecedented inflation,

Today, the world is experiencing an unparalleled inflation of asset prices. This is the first time ever that the world is experiencing asset price inflation in all asset classes (e.g. property, bonds, commodities, stocks and even art!) and in all major nations (e.g. US, China, Japan, Australia, UK, Russia, etc). We will repeat this point again: never before had such a universal scale of asset price inflation ever happened in the entire history of humanity!

Marc Faber believes that the end of this universal boom will be a “colossal bust.” As he explained in the interview at Faber Says Fannie, Freddie Should Split Up, Not Get Aid, the worst case scenario is that this colossal bust will be

… with inflation. I think there is a very good chance that we will have bad economic environment but still rising prices simply because we have money printing institutions around the world called central banks.

At the same time, Marc Faber has scathing remarks about Ben Bernanke and the Federal Reserve,

… the Fed is totally ineffective and inept organisation. That has to be said, they don’t understand simple economics. Because Mr Bernanke reads and writes about the Depression years; the difference between the Depression years and today is that commodity prices had peaked out in 1921 and they were in well-established down trend. Today’s situation is that there are 3 billion people are joining the global economy who are eating and driving around more and more and they put pressure on commodity prices. This is an inflationary environment, not a deflationary environment. And if some Fed member does not understand that, then he shouldn’t be at the Fed in the first place.

It looks like Marc Faber is in the long-term inflation camp (see Are we heading for a deflation or inflation? for the quick run-down on the inflation-deflation debate). And we must emphasize the adjective, “long term,” in the previous sentence, just in case others will think that we do not believe deflation can happen.

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Posted in Economics/Finance, Looking Forward | 34 Comments »

What type of recession is coming?

Monday, June 16th, 2008

Currently, there is a lot of chatter on the topic of recession in the United States. A wide spectrum of opinions on this topic exists, from the belief that the US will avoid a recession (e.g. Matthew Johnson- his view is at Treasury Two-Year Notes Head for Biggest Weekly Loss Since 1982) to the conviction that the US is already in recession (e.g. Warren Buffett). What is our view on that? They can be found at Example of precisely inaccurate information.

Among those who believe that the US is heading for a recession, there are wide ranging views on what type of recession it will turn out to be be, namely V-shape, U-shape or L-shape recessions. What do these shapes mean?

A V-shape recession is one that is short and sharp, which is then followed by a rebound back into economic growth. An example of such a recession is the one in 2001. Right now, the stock market is roughly priced in for such a recession. This is also the official viewpoint of the Federal Reserve.

A U-shape recession is one that will be deeper, longer and thus more painful. But eventually, there will be a recovery back into economic growth. This is the opinion of one of the more bearish economist, Nouriel Roubini, who, up till now, has a very accurate forecasting track record.

A L-shape recession is one that will be deep, long, prolonged and drawn-out period of economic stagnation. An example of such a recession is what happened in Japan since the 1990s. It suffered economic contraction for the past 15 to 16 years and had recently climbed out timidly out of recession. Now, Japan looks to be falling back into recession again.

So, since the stock market has priced in a V-shape recession, guess what will happen to it if the recession turns out to be a U-shape, or even worse still, L-shape?

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Posted in Economics/Finance, Looking Forward | No Comments »

How is Australia’s mining boom sucking resources out of the economy?

Wednesday, March 12th, 2008

Back in Rising metals price=rising mining profits? Think again!, we questioned the rising profitability of the Australian mining sector,

The key point to note is that higher metal prices do not always translate to higher profit. Higher prices merely translate to higher revenue. Profit is the excess of revenue against costs. So, despite rising revenue, profit can actually fall if costs rise faster.

Rising costs is a sign that the economy is running out of resources to expand further. For the mining sector, these two articles in the news media illustrate the current situation:

  1. Fixing the resource boom’s bottlenecks

    2. THE good news is that the nation’s commodity exports fiscal year as the resources boom kicks in to full swing. But the question has become whether the mining industry can deliver the Australian Bureau of Agricultural & Resource Economics.

    Latest figures from the Australian Bureau of Statistics, released on Wednesday, showed exports of mineral ores were down 2.9 per cent in the December quarter while total mining production volumes slipped 1.6 per cent across 2007.

    A major part of the problem in taking full advantage of the once-in-a-lifetime resources boom is the clogged infrastructure on the eastern seaboard, namely the production chains leading up to and including the ports at Dalrymple and Newcastle.

  2. ‘Predator miners’ poaching sub crews

    3. CASHED-UP mining companies were lying in wait outside naval bases to poach submariners, fuelling a critical shortfall in crews for the Collins class submarines.

This is the dark side of the Australian mining boom. Although the booming metal prices is beneficial to the Australian economy, there is not enough resources (e.g. infrastructure and skills) in the Australian economy to fully take advantage of that. It has come to the point that the Australian mining sector is fighting against the rest of the economy for resources. As we said before in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

Therefore, in order to put the economy back into a sustainable growth path, consumptions and investments have to slow down in order to allow for the economy to catch a breather for the rebuilding of its capital structure. The rebuilding of capital structure is necessary for the economy to replenish its resources for the future so that growth can continue down the track. Unfortunately, this rebuilding itself requires resources now.

That is the reason why we believe the Australian economy is heading for a recession, which we had already sounded the alarm back in February last year (see Where are we in the business cycle?). It is actually a good thing, except that many Australians cannot afford to go through a recession because of debt.

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