Wednesday, December 27, 2006

Some 2007 Prognostications

As a "Cassandra", I would be remiss if I didn't offer some more general predictions for the coming year 2007 - particularly the kind that hopefully will stimulate debate because they are contentious. Of course, as the legend goes, few will believe them irespective that many will come to pass....

1. US Housing "Crisis" will be shallower than pessimists believe.
This one is easy. So long as central banks accumulate reserves, allowing US deficits to persist and grow coincidental to stable interest rates, economic growth will NOT implode and nominal house prices will stabilize preventing the apocalypse - at least for the moment. This doesn't mean "Buy Homebuilder Stocks", but it does mean that if one was considering purchasing a home, one shouldn't fear that he bottom will drop out further. Rather nominal tides will rise to float most boats.

2. "Intermediate Frame Price Momentum" will continue to be a factor that strongly contributes to Stock Returns in Japan.
Contrary to popular belief, wisdom, and experience, what outperformed in the recent intermediate frame will continue to outperform. This will, be due to a combination of continued money flows by investors alreadyh invested in japan alongside continued earnings growth of enterprises that have been experiencing earnings growth. This unspide-down world (for Japan) will perplex reversion-oriented traders, and reward trend-followers, however,, hollow and shallow theior relative intellect may be.

3. Contrary to contrarian calls by KBC's Jonathon(!!) Allum Dec07 Topix ~15000 call (note: this was incorrectly referred to originally as Nikkei~15000 -ed.), the Nikkei will rally to 20,000 and the TOPIX will rally to 2,000 (not necessarily in that order).
BOTH Large cap and small cap will rally as Japanese asset prices continue to look both relatively and absolutely attractive on a world stage where the only action is inaction."God Bless Apathy!" said one long and leveraged English Hedge Fund Manager

4. PM Abe will visit Yasukuni
....but he will do so under the cover of darkness. Unfortunately papparazzi will not be denied and yet another Japanese Prime Minister will once again have to explain the inexplicable.

5. California's official sponsorship of Universal Healthcare will prompt national debate on the compelling wisdom of universal healthcare, and the even-greater wisdom of a single-payor
Shares of HMOs will tank as the market begins to conceive of a healthcare world less-intermediated. America will receive [unwelcomed by Conservatives] advice from France on systemic reform, and as in 2003, America will again harass and fun of the Frenc, despite the wisdom and correctness of their advice.

6. US dawdles Yet Again on Energy Policy - Oil avgs $75bbl in 2007
The side effect of continued US deficits underpinning global demand combined with stubbornly pig-headed lack of energy policy and no carbon taxes is energy prices stay firm, and rally. At least once during the year, a crisis will cause a spike in crude to within a millimeter of triple digits. Refining margins will NOT deteriorate, and Valero (ticker VLO) will return 50%. Nippon Oil will be a stand-out investment in Japan also appreciating 50%.

7. Wolfowitz is Impeached and Relieved of Command as President of the World Bank
"Mutiny on H-Street" it will be called. The only thing more stupid than placing John Bolton in a diplomatic position was ejecting Paul Wolfowitz from the Pentagon to the helm of the World Bank. Many are still pinching themselves (those that haven't resigned) perplexedly asking themselves "How did HE get here??!?" OK its too early to say "things are right as rain", but little by little in bite-sized moresels, the good guys are reclaiming control, to the eventual benefit of humankind.

8. "The Carry Trade" Makes it to the Cover of Time Magazine
No major move on the RmB. Pathetically small increases in the BoJ discount rate. No move in US fiscal or monetary policy. No GCC currency appreciation. Continued reserve accumulation of USDs by all the usual suspects. All will mean the carry trade lives. It will make the cover of time magazine because a hedge fund manager consortia in partnership with a private-equity consortia will propose to take the entire remaining S&P 500 private, using - yes, you guessed it - YEN financed funds from Japan. This will get Congress to hold hearings, at which Rep. Barney Frank will chide Lloyd Blankfein & John Mack for "shitting on their own dinner plates by facilitating and participating in the "Stealing of America's Assets".


debt is wealth said...

I feel I cannot intelligently comment on a bunch of these, and the rest I pretty much agree with, but I'm fairly sure you're wrong on #s 1 and at least part of #8. The reason is that the data is already to the contrary for both. I prove each point with a chart:

1) zestimate price of my dad's house in Alexandria, VA (one of the main suburbs of DC). dark blue line (light blue is the zip code).

I'll note that the DC area is "supposed to be strong"; after all, if anyone's creating jobs, it's the Federal government.

The national data also shows nominal price declines, depending on how you slice and dice it, but it seems likely the reality is much worse than the aggregate statistics.

I know too many people gummed up in real estate disasters right now, already, to believe that this is going to be anything but extremely, extremely ugly.

This is something you might have to actually be in the US to sense (as opposed to just reading the polyannaish headlines).

2) A recent chart of the Dollar vs. the Yuan

Note that there's been more appreciation since last year's one-time 2% revaluation than during that revaluation itself. And it appears to be accelerating. Hmm.....

Anonymous said...

Under normal circumstances, I would agree with you. But these are not normal circumstances, and - globalization asides - inflation IS the really big risk (at the moent). Housing will implode/condense/combust IF and only IF the economy is allowed to recess (or overpowers attempts to keep it afloat). IF - as seems apparent given ther risks of debt deflation if the normal cycle runs its course or the Feds decide to chip away at the budget morass - housing will simply flatline in nominal terms (depreciating markedly in real terms but not sinking the owners or their creditors). It may, like England and Australia, actually perk-up and continue a small nominal ascent (though still eroding in real inflation adjusted terms) for if the authorities have their way, inflation will outpace almost all asset price rises/movements, housing included. That's my story, I am sticking to it (for now).
Tnx. for the comment

Anonymous said...

"if the authorities have their way, inflation will outpace almost all asset price rises/movements"

So you don't follow the deflation camp?

Where do you stand on the probability of stagflation?

Anonymous said...

I used the analogy before that the US economy is walking a ridgeline on one side deflation, on the other inflation. During times of balance and normalcy, the walls of the valleys below the ridgline are gently sloped like the Appalachians. Verring to one side of the other means stereotypical recession or mild & elevated inflation. During times of great imbalance, they are steep like the Dolomites. A drop towards deflation - given the outstanding debt entails a serious recession - possible depression. Yet further monetary priming and fiscal stimulus combined with accumulated indebtedness, and accelerating growth globally means larger inflation than is desirable and sustainable in an economy without - eventually - dramatically higher interest rates. We are are in the latter where which ever way we slip will be painful. Staying on the ridgline entails evermore work. Imagine being tired and carrying a 75lb pack. A breeze can make one loose their balance. Staying on the ridgeline at this stage probably looks like stagflation albeit mild. But look ahead (given continuing deficits & imbalances and no policy actions): and the path gets steeper and more difficult.

Eventually it ends in deflation, or revolution. Continuing inflation will only further increase income disparities.

I prefer recession now, in order to release the pressure and prevent a revolution later which will be more dislocating and ugly for everyone. In this sense, I believe rolling back the income tax cuts on the wealthiest; imposing wealth taxes on assets above a threshold($2mm net worth) say 50bp p.a.. Impose various and rather draconian energy taxes, and impose a nationwide consumption-like tax. This will allow us to reduce interest rates & lower carrying cost of debts, encourage foreign consumption in lieu of US unilateral consumption, diminish imbalances - especially energy, and quash inflation. In the absence of this, the Fed should raise rates, and then trade higher rates for increased US taxes and appreciation in YEN/RMB/GCC curencies. The US needs to stop being passive, and broadly define its national interest as something greater than Wall ST. and Corporate profits.

Anonymous said...

"But look ahead (given continuing deficits & imbalances and no policy actions):"
... that's what I'm trying to do, because I don't think that any of the politicians will take anyone's good advice. (Analogy that jumps to mind: global warning).
I don't think anyone will step up.
(Although in reading someone's blog-and-comments, there were references to Paul Volcker having raised interest rates until he got policy and spending concessions from Congress ... I like that idea, but think it unlikely to happen in the next 5 years).
So, everyone's earnest advice is going unheeded (everyone's except Morgan Stanley, et al).
As a result of no action on the US' accumulating debt and decreasing productivity/revenue, and the increasing currency diversification of foreign central banks, when I look in the future I see increasing inflation. And, as you point out, increasing disparities in income/purchasing power and class conflict.
It's frightening.
Are there any historical precedents?

PS I feel inflation affect my life now but all the headlines say that it doesn't exist. Is getting ordinary citizens to doubt their own percepts one of the ways of staying on the ridgeline?

debt is wealth said...

Here are my thoughts on inflation vs. deflation (mirrored from something I posted elsewhere).


The inflation vs. deflation argument is a false dilemma.

The only time the US has ever had significant deflation (the Great Depression), it was followed by inflation (intentionally). Why? Because any major credit/money contraction cripples industry, which is bad for employment, which is bad for stability (not to mention international competitiveness). So the government does what it thinks it needs to do to get things moving: which is invariably something inflationary (may not literally be the printing of greenbacks).

While we have a number of "innovations" in our system that make direct comparision to the great depression, the Weimar republic, the 70s in the US, etc. difficult, the underlying situation is the same: too much money/credit has been created, and ultimately whatever part of this isn't cancelled with turn into broad price inflation. The only way this could be totally avoided, so that we only experience deflation, would be to somehow immediately reduce consumption (both national and individual) to its sustainable level.

No way in hell that's possible.

The point about broad price inflation also reminds me: there's another aspect clouding this debate, which is exactly what is inflating or deflating. In a sense, an contraction of money/credit/asset values in any market is "deflation", but this doesn't usually translate to overall lower broad prices.

I don't think we'll have much broad price deflation. I'm in the Eric Janszen camp: we'll have "disinflation" (possibly peaking now) and then high or hyper inflation. As he'd put it, we've already had the "ka"; get ready for the "poom".


As an epilogue, I'd say we're already having both deflation and inflation: the stock market has been deflating since 2000 and the housing market is deflating (I wouldn't consider the energy pullback since the late summer to be anything more than a trading pullback).

Yet, higher interst rates, rents, the gradual increase in commodity prices, and more expensive imports can do little more than contintinue to provide inflationary pressure (as they were clearly showing for most of 2006).

As for Japan, I would say Japan definitely had both inflation and deflation: domestic prices (especially in things like real estate) clearly deflated (or disinflated), but Japan's monetary base expansion which turned into the Yen carry trade essentially inflated financial markets all around the globe (most notably in the US).

Anonymous said...

Thanks for the Janszen reference. What he writes makes intuitive sense to me (I've gathered that intuitive sense is not much valued on economic blogs but I'm new to all this and and probably understand a fourth -- at best -- of what I read [RGE, Cassandra, The Big Picture] so intuition is for me more 'reliable' than analysis).
I think what you were saying is that "deflation vs inflation" makes no sense as one won't exclude the other. And, one will precede the other; both are phenomena of 'great imbalance/steep like the Dolomites'??

debt is wealth said...

Yes exactly, anon -- you've got it.

More is available in my article and the discussion comments here.

Anonymous said...

Thank you for the link -- fascinating site and analysis. What you wrote (scarily) made a lot of sense to me, especially:
"I think we are being setup for failure here in a way similar to the way misreporting the price level "builds in" an inevitable correction -- because debt grows "too quickly" to the extent inflation is being misreported. If risk is similarly mis-priced, then too many derivatives are built on top of too little reserves and income streams, so when it is realized risk is actually higher, there aren't enough participants capable of "paying all that insurance"."