Monday, 10 December 2012

Sick . . .

I've fallen victim to the bug thats been going around Sydney at the moment and have been unable to do much other than sleep. The last time I was on one any of the bikes was Saturday. Normally with this much time on my hands I would have got out the cleaning rags and oil to give all the bikes a good tune-up, but with little energy even that has proved impossible. In the meantime I'm trying to get to grips with news hitting the tapes in respect to initiatives by authorities in the UK and US regarding the concept of too big too fail.

The trouble with too big too fail has always been that it took the risk away from the equity, bond and deposit holders and transferred it to central government. Now the proposal seems to be to move to a core system of banks that are in some way insured, be it by increased equity requirement, modified deposit insurance or something else regulators are yet to think of. Essentially if you're a member of the public interested in depositing your savings you'll probably be presented with some form of modified health warning . . . much like buying a packet of cigarettes.

As an investor the quid pro quo is going to be lower return on equity. Banks in the core group will have an implicit put option for depositors by virtue of their expanded capital base, but the price for investors will be whatever the market charges for funding al of this. At the moment the hurdle rate is very low because interest rates are low. As an investor if you can finance at sub-3%, then a return of 7 - 9% might seem OK. What if said costs rise, as it might if the current bond bubble bursts? What if the RoE at banks was less than WACC? Clearly no one would want to own the equity and even the bonds might have questionable value. Those banks would then have to shrink their balance sheets in order to attract capital. This is why I believe that as the new regulatory environment takes hold the winners will be the strongest of the non-systemic investment banks (such as GS) who will have the flexibility to compete for deals with the highest returns. 

All of this is academic to the man on the street, who if in Japan sees only that the country continues to shrink with its' ageing population. Japan is now in a technical recession and even if some of that has been brought about via the posturing with their Chinese neighbours then most of the blame still goes towards the inability of successive governments to adequately respond to the post real estate bubble economy of the last 20 years. Japanese GDP showed that output slipped by 0.9% the September quarter, but the government revised down the previous quarter’s estimate to an annualised 0.1% contraction, thus triggering the technical recession. Perhaps the weakening yen will help generate some internal optimism?

China is sill suffering from a lack of international demand. In November they recorded a USD19.6bn trade surplus, that's the lowest for the last five months and must be of concern to the local leadership who for all the posturing about rebalancing their economy still rely on exports  to finance an increase in the standard of living for the masses. All this of course goes against the grain of what we've been seeing on the industrial production side of the economy, which was pointing up. That was one of my primary reasons for looking more closely at Chinese equities recently. China IP increased 10.1% cent from a year earlier in November (up from 9.6 per cent in October). Retail sales rose 14.9 per cent year on year, up from 14.5 per cent. All of this leaves me in a quandary. Is the Chinese IP data a leading indicator of something not yet obvious . . . I hope so.

Maybe the European economy is about to come back with a vengeance? I got sent a series of charts showing that the various European indicies were being edged into tighter and tighter trading ranges. The small optimist in me suggests that this may signal a breakout higher because seasonally you rarely get a bad Q1. Who knows? I'm not in Europe any more and it's harder getting day to day information on this possibility. 


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