Economic and market themes: 2014-03-21

  • Sanctions because of the Crimean crisis have had less economic impact than private portfolio preference shifts. However, as Ukraine moves into the EU sphere, further actions against Ukraine could be more far-reaching.

  • China has moved toward stimulus to avoid a hard landing

  • Signs are abundant that risk assets are overpriced and that de-risking is in order

  • Wage and job growth in the US is weak and supports 2% growth at best


In Ukraine, the risks of continued escalation dominate the picture at present. But this is just a risk, not a base case. The annexation of Crimea is a done deal. All sides – the US, the EU, Ukraine and Russia – seem to accept this. The question now concerns reactions and next moves and the reactions to those moves.

Right now, Ukraine appears to have signed an association agreement with the EU, bringing it officially into the EU sphere of influence. The price it will pay for the agreement is economic liberalization, which means gas subsidy cuts, austerity, and therefore probably an inflationary downturn. In return, Ukraine will get loans to avoid default and move closer to the EU umbrella.

On the sanctions front, the EU is divided over what sanctions to apply. And the US cannot go out on a limb and apply much harsher sanctions on Russia than anyone else because it would look like an isolated move. Therefore, the most we are going to get in terms of sanctions are the types now being applied to individuals and the minor one applied to the one Russian bank. In my view these are symbolic, as are the counter sanctions. They have no real economic effect. A much greater effect has been felt via portfolio preference shifts that is causing the currency and markets in Russia to fall. However, now that Ukraine is going to be in the EU orbit, if Russia takes military action against Ukraine, it will face severe economic penalties.


In China, the government has indicated the fall in economic activity has been severe enough that they have decided to reflate with stimulus.

According to Bloomberg News:

China will speed up construction projects and other measures to support the economy after a slowdown in industrial-output and investment growth boosted risks of missing this year’s expansion target.

The nation will “seize the moment to roll out already-determined measures in expanding domestic demand and stabilizing growth,” the State Council, or cabinet, said in a statement last night after a meeting. China will “accelerate preliminary work and construction on key investment projects with timely assignment of budgeted funds,” it said.

This is, of course, counter to the slower credit growth/rebalancing mantra we have been hearing. But it is also a sign that China refuses to allow a full-speed unwind process to destabilize the economy. Thus, for now, there is a floor on how low things will go. More investment means more overcapacity, however.

Junk and risk assets

I thought it was interesting that Jeff Gundlach signaled he was de-risking by reducing high yield in his portfolio allocation at the same time we hear of a $2 billion hedge fund for Dominique Strauss-Kahn. Let’s put a marker here. It sounds to me like we have two good markers for excess in risk assets that should signal de-risking.

Two other signals for me in tech are also of note. One is the valuation of Alibaba the Chinese e-Commerce site. Alibaba bought Yahoo out in 2012 at an implied valuation of $35 billion. Two years later, the company is being marketed for an NYSE IPO at a $150 billion market cap. And this is a company that has less than $1 billion in net income per quarter. Then you have Airbnb, which is getting money at an implied $10 billion valuation. This is a company that allows people to rent out their houses as if they are bed and breakfast hotels. That’s it. It doesn’t own any property. It is just an exchange – and a loss-making one at that. But now it’s worth more than Hyatt Hotels.

We are in full-on overvaluation. Jeremy Grantham recently estimated that stocks were 65% overvalued. So that tells you we would have a long way to fall if we reverted to mean and overshot as we always do in a bear market.

North America

In the US, I am still looking at job and wage growth for signs of economic sustainability. The jobless claims series has trended down over the last two weeks, which is great. Of course, year-over-year comparisons are harder to beat now because while we are at a sub 330,000 4-week moving average with 327,000 on initial claims, the comparable figure was 340,750 a year ago. So despite the drop in claims, the year ago comparisons are actually worse now than they were two weeks ago. And remember that recessions are based on first derivative statistics i.e. it is the change in GDP that causes recession. So the change in jobless claims matters more than the absolute level in terms of understanding shifts in GDP growth or susceptibility to recession.

On the wage side, inflation-adjusted wages rose 1.1% in the year through February according to the US department of labor. The 2.2% increase in hourly earnings was decreased by 1.1% inflation to come up with that figure. What that tells me is that the 2% GDP growth figure I have put forward as trend is about right if you consider the modest releveraging now happening and an increase in capital investment. But again, these are not great numbers. Just as with the jobless claims figures, we are not seeing anything in the real economy which should lead us to believe strong economic growth is around the corner in the US.

This will not stop the Fed from reducing its asset purchase program. And I don’t believe it will materially change it’s hiking timetable unless unemployment begins to rise.

I am going to leave it there for the week. Have a great weekend.

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