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About Me

Darren Winters is a self made investment multi-millionaire and successful entrepreneur. Amongst
his many businesses he owns the number 1 investment training company in the UK and Europe.
This company provides training courses in stock market, forex and property investing and since
the year 2000 has successfully trained over 250,000 people.

Thursday, 28 August 2014

Monetary Policy

The accelerator throttle controls the revolutions per minute (RPM) of an engine similarly to the way the money supply, in any given economy, influences the rate of economic activity. When the engine (economy) under idles, the driver simply pumps the accelerator (money supply) to increase the RPMs (economic activity). Conversely, if the dashboard indicators show the presence of an overheating engine (inflation) the driver (bank governor) can ease off the money supply to cool the economy down.

In essence this is Monetary Policy, which is commonly defined as a government strategy of influencing economic activity by controlling the money supply. The task of controlling the money supply is usually delegated to a Central bank, in the UK it’s the Bank of England, in the US the Federal Reserve (FED) and in the European Union (EU) the European Central Bank (ECB) that is responsible for controlling monetary policy. Central banks can use three tools in their kit to influence the money supply. They are as follows; the buying or selling of national debt; changing interest rates and the changing of credit restrictions.

Monetary policy has been and still is in vogue with policy makers since it is promoted as a viable solution for manipulating economic activity through the money supply rather than taxation. So it is no surprise then that monetary policy is favored by political parties of the centre; centre right, such as the Conservative’s in the UK and Democrats in the US who advocate low tax regimes and less government spending.

In the financial crisis of 2008 in order to prevent a financial implosion and another Great Depression II that would have inevitably ensued, Central Banks around the world pumped the system with liquidity. Quantitative easing (QE), it was believed would bring the system back from the precipice and save us from misery. So central banks entered the bond market and bought historic amounts of sovereign debt, which in turn triggered the desired effect of raising bond prices, or gilts in the UK, which then lowered interest rates. With interest rates kept at record historic low rates of near zero percent, this would stimulate investments, increase demand and lower the unemployment rate, so the theory goes.

Six years on and doomsday predictions of another Great Depression have fortunately failed to materialize, however some may argue that in the peripheral states of the EU they are already experiencing the effects of a Depression with mass unemployment rates of over twenty percent in Greece, Spain, Portugal and Cyprus. Nevertheless, the ECB has decided stick with the policy of monetary expansion to keep the economy ticking over. In June, ECB bank governor Draghi decided to do more of the same by cutting base rates to 0.15 percent from 0.25. Additionally, deposit rates are now entering uncharted waters of negative 0.01 percent; the implications being the ECB will now actually charge its clients for holding funds overnight in a deposit account. But if the previous repeated cuts in EU base rates haven’t improved the situation, it beggars belief to think that these new round of historic base rate cuts are going to have any different effect. So perhaps the rate cut in June, which frankly is soon approaching zero percent from near zero percent, indicating a policy with now little or no leverage is merely nothing more than just a symbolic move from the ECB Governor Draghi. Despite years of expansionary monetary policy the south remains plagued with chronic unemployment, credit is tight since banks are still reluctant to lend, preferring the alternative option of rebuilding their balance sheets from the last financial crisis of 2008. Moreover, there’s even fear of the dreaded deflation gripping the economy, an unwelcomed prospect since lower prices deter business from investing and consumers from spending, which then metamorphoses into a downward economic spiral. Recent economic sentiment in Europe’s powerhouse, Germany isn’t entirely upbeat either. The central bank in Portugal recently reported that it needs to be rescued from bankruptcy. Additionally, there were talks back in February that Greece might need a third bailout. In short, expansionary monetary policy to the full throttle hasn’t really been effective in the Euro zone. 

With respect to the UK economy, while mainstream likes to paint a bright spot. Perhaps things are not so bright in what has been described even by some optimists as a “lumpy recovery.” Looking at the facts industrial production and construction are still down respectively by 10 percent each since the financial crisis of 2008. Moreover, the era of money pumping which ought to have spurred on capital intensive activities like industrial production and manufacturing may have fueled a speculative bubble in the bond market, equities and London property prices.

So maybe pumping money full throttle has actually skewed investor’s perception of risks and encouraged investor risky behavior, thereby creating a bigger bubble and a bigger bang when it eventually pops. Paradoxically, while pumping money supply full throttle might have prevented the economy from stalling, in the short medium term, it could have also caused unintentionally and engine blowout.

The flaws with monetary policy is that while the central bank can manipulate the money supply, the monetary authorities can’t actually control what the business community and investors do when they are presented with a period of cheap money. Who is to know whether investors will use the cheap money to buy gold, bonds and companies to buy their own shares?

It’s much easier to predict what happens with a machine when you increase the flow of fuel and air into its combustion chamber, but when you throw human behavior into the equation then it becomes guess work.

Whether monetary policy is now defunct depends on what will happen in the economy and the markets in the near future. But when the monetary authorities do much of the same thing, a quote from Albert Einstein comes to mind, “Insanity is when you do the same thing over and over again expecting a different result.”

Friday, 22 August 2014

Whistle Blower

The economic doctrine that market prices are determined by supply and demand doesn't fully explain how market prices are set. In practice there are other factors at work which could also have an influence on prices. For example, when suppliers collude to set prices at a certain level the laws of supply and demand are frankly irrelevant. 

This actually does happen in the markets and there are many instances when suppliers get together, behind closed doors to form cozy fixed price agreements. This is known as a supplier's cartel and there is an obvious commercial benefit for the supplier to form cartels; put simply by keeping prices artificially high they are able to extract monopoly profits.

In theory, cartels are illegal and frowned upon by market regulators because they distort the workings of the market, stifle competition and make buyers pay more should. 

But in reality, if the supplier is operating a cartel and is just too big to jail, or bust, then again we see double standards at play. The most famous mother of all cartels is the Oil Producing Export Countries (OPEC). Think about it; OPEC members meet on a regular basis to discuss output quotas. When the members believe that future global demand for oil is likely to fall, due to say the northern hemisphere moving into summer for example, or a slowdown in global economy the dons of the oil world typically decide to cut output, which has the effect of maintaining oil prices at their coveted level with the aim of retaining profits. Conversely, if the OPEC member countries take a bullish view, they could decide to increase quotas. So what we have going on in the oil market is member countries getting together, or colluding on output quotas, in order to fix oil prices.

Then apply the “duck test,” "If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.” Isn't that a cartel? 

Therefore, with it being common knowledge amongst traders that the oil market is manipulated by the world's largest and most famous cartel OPEC, could there be other markets that might also be rigged.

Take for example, the precious metals market. The famous whistle blower, Andrew Maguire comes to mind. Probably, the name sounds familiar to every precious metal trader. Indeed, Mr. Maguire, features high up the list of famous whistle-blowers. Mr Maguire, an independent London-based metal trader for thirty years standing, dared to say what most precious metal traders suspected; that precious metal market was rigged.

In an interview with CBC aired in April 2013 Andrew Maguire described how cryptic traders, allegedly working for the bullion banks JP Morgan and HSBC waited for the major exchanges from Shanghai to London to be closed then channeled their dealing on COMEX, which is the primary market for trading precious metals, such as gold, silver copper and platinum . He revealed in the interview that traders were trading virtual or electronic silver anonymously using “algorithmic trading systems,” which is a fancy name for saying automated trading on electronic platforms. Trading orders are entered with an algorithm and pre-programmed trading instructions, which might include the following variables; price, or quantity of the order. When certain variables are reached the trades are triggered by automated computer programs. So the trades aren't executed by human traders but via a programmed computer.

Algorithmic trading is widely used by investment banks, pension funds and mutual funds and other buy-side (investor-driven) institutional traders, to divide large trades into several smaller trades to manage market impact and risk. The advantage of using computers, rather than humans to trade is that the former can execute trades at the speed of light. So it’s not difficult to see that if you have a participant in the market with massively deep pockets with the ability to execute trades at lightning speed prices can then be determined as and when they decide to hit. In the words of the whistle-blower, they were, "moving in and out of the futures markets at the blink of an eye. Four hundred contracts a second, each contract represents 5,000 troy ounces of silver." Maguire described a sudden and massive wave of selling of up to 45,000 contracts which drove the price of silver down. "Investors big and small tried to cut their losses and sell as the price drops." People who had invested heavily lost everything. Then the mysterious seller just as suddenly started buying the electronic silver again. The price of silver soared as did profits for the seller. 45,000 contracts with a profit of $80,000 per contract totaled $3,600,000,000 (3.6 billion USD) for the mystery seller.

So at some point the dons decided to attack the market, they flooded it with massive silver selling at lighting speed, the market tumbled the bulls cut their losses and also sold. Then the dons reappeared snapping up silver at rock bottom prices and made a killing.

This is another classic example of market manipulation, it happened, it’s not fiction and it’s probably happening right now. Retail investors need to be mindful of this and always take extra care when margin trading, if you can't afford to lose it don't play it/the game.

Market Summer Debate

There’s been a hot debate raging in the markets this summer, which has probably intensified following last month's sell off in the global markets, concerning the future trajectory of the equity markets. In one camp are the pessimists, the bears, who are adamant that this five and a half year secular bull market has reached its top and that the markets from here on will be entering a new bearish trend. But on the other side of the argument are those who are taking a more optimistic, or bullish view on the equity markets. The bulls believe that this recent correction is healthy and that in actual fact we are midway through a secular bull market, which will keep charging forward and clocking up more gains for probably another five years.

Last month's sell off dragged the DOW and the FTSE slightly into negative territory for the year and the bears are making a compelling case for a 20 percent market correction, which according to them has already commenced with last month's sell off. The crux of their argument is based on all three conditions simultaneously taking place, which has been remarkable in accurately predicting six bear markets within the last 40 years. The signals in question are excessive levels of bullish optimism, significant over-valuations and wide discrepancies in the performances of different market sectors. Indeed, a review of market trends since the early 1970s would indicate that no bear market has come into effect without these three conditions being fully satisfied. So when all the stars align this is the clear signal for a new bear trend, according to Hayes Martin, president of Market Extremes, an investment consulting firm in New York whose research is focused primarily on major market turning points. There have already been six times since 1970 when the market experienced irrational exuberance, dizzy evaluations and a wide variation in the performance of different market sector, according to Hayes Martin.

The first two of these three market conditions, an oversupply of bullish investors, and record overvaluations, have been evident in the markets for the last few months. For example, during December of 2013 the number of advisers who described themselves as bullish rose to above 60 percent, the latest reading on July 30 was 56 percent, nevertheless, still a reading which is in danger territory, according to a market consulting firm. Certainly, it would appear that there’s an element of contrarian investing behind this oversupply of bulls signal. In other words, to be fearful when everyone is greedy and greedy when everyone is fearful. With respect to the latter signal, excessive evaluations, this is also clearly present in the market with the price/earnings PEs ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rising in December 2013 to its highest level since the benchmark was created in 1984. The PE ratio at the end of 2013 is higher even than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

Another signal bears are getting excited over is the waning participation of traders, or lower trading volumes in the market, which has declined rapidly in the last month. One way of gauging this waning participation is by calculating the percentage of stocks trading above their average over a given time. This refers to analyzing the stocks moving average, which is a widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random price fluctuations. For example, the percentage of stocks trading above an average of their prices over the previous four weeks fell from 82% at the beginning of July to just 50% on the day the S&P 500 hit its all-time high. It was one of “the sharpest breakdowns in market breadth that I’ve ever seen in so short a period of time,” said Martin.

But don’t be so confident in your predictions of calling a new bear trend in the markets says Deutsche Bank chief strategist Binky Chadha. The likelihood of a selloff of at least 20 percent, which would define a bear market is unlikely, according to Chadha. Rather, what we are seeing is a secular bull market in mid-cycle. So if we see the market fall by say 10 percent, that is healthy, according to Chadha. But a correction of 20 percent doesn’t seem likely for this analyst, since three-fourths of such corrections happen near recessions and almost never occur when the trend in the unemployment rate is down, chadha concludes.

Nevertheless, there are the black swans to consider, the geopolitical situation in the Middle East, the looming sovereign debt crisis, the EU’s economic and political crisis and tit for tat sanctions over the Baltic crisis could all weigh heavily on the markets.

Whether what we are seeing is a mid cycle secular bull market or the beginning of a bear cycle is hard to gauge, particularly when we analyze the fundamentals and throw into the equation the unknown variables, there are too many in this market. Maybe technical analysis might be a better tool in trying to see through the muddy water, after all the signals are clearer.

Thursday, 14 August 2014

EU Bank Losses

The recent massive losses of some of Europe’s largest banks is alarming, particularly at a time when European Central Bank (ECB) is pulling at maximum on the expansive monetary policy lever in what may be a futile attempt to alleviate yet another looming credit crunch.

Portugal’s largest listed bank, Banco Espírito Santo, is currently tinkering on bankruptcy after reporting a shattering first half loss of 4.8 billion USD, shares in the bank collapsed by 50 percent on Thursday. Banco Espírito Santo’s historic loss has wiped out the bank’s €2.1 billion capital cushion and leaves its solvency ratios well below those demanded by regulators. The Portuguese bank is now scrambling to raise more capital to stem off a potential bankruptcy. Most of Banco Espírito Santo’s 4.8 billion USD losses have been attributed to bad loans made to the Santo family business Empire, which has been collapsing since early July when one of its companies failed to pay a loan. Moreover, three Espírito Santo holding companies have filed for bankruptcy protection, since then. The requirements to build more financial robust contingency measures, to weather future losses, has also been cited by the Bank as contributing to the Banks massive first half losses. The bank said that at least €856 million was needed to cover possible losses on credits granted without proper internal clearance. Indeed, reckless lending has been made by its banking unit in Angola, called Banco Espírito Santo Angola, more commonly known as BESA, when it made loans equivalent to 220 percent of its deposits. The end result being that the Angolan taxpayers had to cough up €4.2 billion in guarantees in December. Banco Espírito Santo has made little reference in its recent earnings report on how it proposes to mop up the mess it created in Angola. However, it did say that it might have to lose majority control of BESA as part of a planned capital increase. Referring to the Angolan situation a spokesman for the bank said that it would, “reach a solution that meets the interests of the Angolan authorities and that which safeguards Banco Espírito Santo’s interest and those of its shareholders.”

The Espírito Santo family has had a strong hold over Portugal’s economy for more than a century. Following
a Portuguese left wing revolution in 1974 supported by the military, resulting in the family’s assets being nationalized, the Espírito Santo family had managed to rebuild their empire. But family fortune has been reversed in recent years with the latest failed commercial activities. Additionally, last week, Ricardo Espírito Santo Silva Salgado, the family patriarch and former head of Banco Espírito Santo, was arrested in connection with money laundering and a tax evasion investigation resulting in the former bank’s boss being ordered to pay €3 million in bail.

Both the Portuguese central bank and Banco Espírito Santo have reassured shareholders and depositors that the required funds can be raised from private investors. Moreover they are reiterating that depositors’ money was guaranteed and that the bank’s distress should not have a negative impact on the broader financial system. Portugal has contingency cash reserves of approximately €15 billion at its disposal, according to the credit rating agency Moody’s, including €6.4 billion of unused money that had been earmarked to rescue its banks as part of an international bailout negotiated in 2011.

But with Banco Espírito Santo’s share so low analysts now believe that the bank might be vulnerable to a hostile takeover bid.

Over the Pyrenees to France, big losses were also reported on Thursday, July 31. The French banking giant, BNP Paribas, posted a net quarterly loss of 4.3 billion Euros ($5.75 billion) for the second quarter of 2014. However, these losses were not related to bad loans. Indeed, the BNP Paribas trading results had recorded an exceptional expenditure of 5.95 billion Euros for the second quarter. This was linked to breaching US economic sanctions, which resulted in record penalties being imposed on BNP Paribas. The US accused the French bank of moving billions of dollars through the American financial system on behalf of Cuba, Iran, Myanmar and Sudan, all under economic sanctions. BNP Paribas had pleaded guilty in June for breaching US sanctions and agreed to pay 6.6 billion Euros as a penalty, if the case didn’t go to court.

However, excluding US penalties imposed on the French bank for breaching the sanctions, BNP Paribas managed to record a quarterly profit of 1.9 billion Euros, which is up 23.3 percent on the same period a year ago. But, the fine has already had a negative impact on the bank’s second quarter results and it will also lower its contingency reserves. The penalties are not only substantial, they are a record amount imposed on any bank, but they also include a one year ban on certain dollar clearing transactions. A spokesman for the bank said BNP Paribas still had enough cash set aside with central banks and capital to absorb any potential future losses. Additionally, Mr. Bonnafé, CEO for BNP Paribas, said the bank had already paid the entire $8.97 billion fine to U.S. authorities, using its large liquidity pool—cash set aside with central banks and assets accepted as collateral by central banks. 

It was also reported that BNP Paribas had acknowledged using regional banks overseas to process more than $20 billion in financial transactions linked to companies and government agencies in Sudan—at a time when the nation was engaged in what the U.S. and others call genocide. 

The French bank has agreed to set up internal supervisors to ensure that the bank complies with international US sanctions.

Regarding the recent Argentinean sovereign default it’s worth noting that Argentina has remained cut off from the global financial markets. So an Argentine debt default may not be so damaging to the global financial markets this time around. Furthermore, the likely amount of debt default of approximately a few USD billion is significantly less than last times non-payment of its 82 USD billion debt. Therefore, Spanish bank exposure is relatively small this time around. Nevertheless, the Spanish banks have their own big problems; a huge mortgage subprime crisis, turning banks into real-estate agents and high loan defaults where one in four of the work force remains jobless.

Thursday, 7 August 2014

Sanctions. EU/US Rift

As the crisis in the Baltic lingers on and regretfully shows no signs of abating, the political fallout, which is manifesting itself in the form of sanctions, is resulting in a European Union (EU) political agenda, which is increasingly becoming more at odds with the bloc’s economic agenda. Perhaps it is no surprise then that EU officials were dragging their feet over US’s enthusiastic insistence to ratchet up the sanctions against Russia over the Baltic crisis. 

The EU, after all is tinkering on the brink of a political and economic abyss. Germany, the engine of Europe is in economic stagnation and a lengthy period of low real wages has meant that domestic demand has been feeble so it desperately needs those exports to Russia. The peripheral countries are mired with mass unemployment and growing wary of a Brussels’ imposed austerity. 

The latest round of sanctions on Russia, which is now coming into force have in their gun sight three main sectors of the Russian economy. Indeed, finance, energy and the defense sector have all been targeted by the new sanctions on the Russian economy. Sberbank, Russia’s largest bank along with three other big titan banks, VTB Bank, Gazprombank, Vnesheconombank (VEB) and Russian Agriculture Bank (Rosselkhozbank) have all come under fire as a result of the new sanctions. Russia’s main banks have been banned from raising capital on the EU’s capital markets. Moreover, loans exceeding 90 days and the selling of bonds to European investors has also been banned. The sanctions targeting banks, with a state ownership of over 50 percent was implemented on August 1 and will be valid for one year. The decision whether to lift or implement harsher sanctions on Russia is expected to be reviewed after three months. “In order to restrict Russia's access to EU capital markets, EU nationals and companies are no longer permitted to buy or sell new bonds, equity or similar financial instruments with a maturity exceeding 90 days, issued by major state-owned Russian banks, development banks, their subsidiaries outside the EU and those acting on their behalf. Services related to the issuing of such financial instruments, e.g. brokering, are also prohibited,” said the EU Council in a statement. 

Reaction soon followed from Russia’s biggest bank. Playing down the sanctions a spokeman for Gazprombank said in a statement that “the measures taken by the EU are almost the same as those imposed earlier by the US” and added that the new sanctions will not have an effect on the bank’s financial stability and work. The local press reported that the bank continues to operate as usually providing services to both individuals and legal entities and transactions both in rubles and foreign currencies proceed without delays. “In these circumstances, Gazprombank continues to completely fulfill its liabilities to investors, depositors and creditors,” the statements published on the bank’s website reads. 

However, VTB Bank was more scathing of the sanctions. VTB said that it strongly disapproves of the EU’s
decision, adding that the bank and all its subsidiaries will continue to operate as usual. “Such actions contradict Europe’s democratic values, showing they have gone against their own interests to do the bidding of their senior colleagues from across the ocean,” the bank said in a statement. “These decisions are incompatible with the core principles and values of the free market, and discriminate against VTB as well as international investors. European authorities have de facto granted themselves the right to decide for investors where they may invest their own funds.” 

With regards to the energy sector, any EU company wishing to provide heavy equipment or technology to Russia will now need to have it approval by officials. The continued exploration of oil in the Arctic might be affected by these new round of sanctions imposed on the Russian energy sector. The defense sector has been slapped with a ban of imports and exports to Russia; however that will not be retroactive. So any military sales of equipment that were authorized prior the ban will be allowed to proceed.

Moscow has slammed the latest round of sanctions saying it was disappointed by the EU’s inability to act independently from the US in the international arena. “We feel ashamed for the EU who, after long searching for a unified voice is now speaking with Washington’s voice, having practically abandoned basic European values, including the presumption of innocence,” said the Russian Foreign Ministry in a recent statement. 

Indeed, the world’s only super power is now starting to flex its muscles again and reminding Europe who’s boss. Is it plausible to believe that France’s decision not to revoke a multibillion euro military naval ship deal with Russia might have been a reason behind the French banking giant BNP Paribas being bullied with a record 6.6 billion Euros penalty for violating US sanctions? It’s worth noting that when the British HSBC violated sanctions and even dealt with UN recognized terrorist organizations and was fined 1.9 billion USD, which hardly sized up to the whopping 6.6 billion imposed on the French bank. 

Moreover, these US instigated sanctions on Russia, which are designed to damage, will probably also hit hard the engine of Europe. German exports to Russia, are worth 36.1 billion Euros and this is something that Germany cannot jeopardize, particularly when growth is stagnant. 

Russia is firing back with its round of sanctions. Putin has warned that EU sanctions will cause energy price increases in Europe. Additionally, EU banks working in Russia could also be targeted in future. Russia’s food safety agency said it may ban imports of U.S. poultry and some European fruit due to contamination of the products, according to a recent Bloomberg report. Russian Deputy Prime Minister Dmitry Rogozin said last week that Russia has the capability to build Mistral-class helicopter carriers on its own if France cancels the existing contract. 

So not only could these sanctions imposed on Russia over the ongoing crisis in the Ukraine have adverse effects on a global scale, according to the IMF but they could also create a rift between the EU and the USA. If history repeats itself then we are in worrying times; in the past there were currency wars, which led to trade wars and then real wars.

IMF World Growth Forecast

The International Monetary Fund (IMF), a heavyweight Washington based institution comprising of 188 countries, with its publicized benign goal of maintaining financial stability, fostering international trade, employment and eradicating poverty, has previously been criticized in some circles for being overly optimistic in its forecasts and getting it wrong. The Greek media recently reported quoting Monetary Fund Chief Christine Lagarde as describing 2011 as “a lost year,” partly because of the IMF’s mistakes. The IMF had publicly admitted that it had wrongly gauged the detrimental impact that austerity would have on the Greek and other stricken states of Europe. 

Credit needs to be given where it is deserved, for at least the IMF has publicly admitted that it
underestimated the effects of austerity in parts of Europe. The economic and social consequences of fiscal consolidation, austerity, are now well documented, suicide rates doubling in Greece, social deprivation on the rise. Austerity may have provided a quick fix, short to medium term solution to financial stability but it has come at a huge social and political cost with chronic mass unemployment in the peripheral states of Europe and a corresponding widening income gap. Moreover, austerity is testing political legitimacy to the maximum in Europe. Certainly, advocating austerity and underestimating its effects has been at complete odds with the IMF’s supposed goal of increasing employment and eradicating poverty.

So what should we now make of the latest July IMF global growth forecast? They don’t make entirely upbeat reading, and that’s a surprise for an institution that has been criticized for making overly optimistic forecasts. Global growth has been revised down to 3.4 percent this year from 3.7 in April, according to the latest IMF report. There are four unforeseen risks in recent months, which have already had an adverse impact on the global economy, resulting in the IMF slashing its growth forecast this year by 0.3 percent. The main culprits are the US, China, Russia and the emerging markets. 

In the US, over capacity in the economy in the final quarter of 2013 has been underestimated and is providing unwelcome headwinds. This implies the likelihood of stronger correction when it comes, according to the July IMF report. Additionally, a hasher winter, apparently dampened demand as shoppers stayed at home. With respect to US exports, they have also declined sharply in the first quarter on 2014, but this did follow a strong fourth quarter in 2013. US output also contracted in the first quarter of 2014. US economic output has been slashed to 1.7 percent for the year, down from 2 percent, previously forecasted by the IMF.

Over to the Far East, in China there’s no cheer either. The Chinese economy is now forecasted to decelerate at a faster rate. The People’s Bank of China, China’s central bank responsible for controlling monetary policy has problems of its own making to contend with. The recent boom in the Chinese real estate, fuelled by loose monetary policy, has spurred on construction without limits with the undesired consequence of creating unaffordable housing and ghost urbanizations. So the People’s Bank of China is on a mission to cool down the red hot economy and tackle inflation by tightening monetary policy. Nevertheless, China is expected to grow 7.4 percent in 2014 down from the 7.7 percent last year.

Moreover, no rave in Russia also, the Russian economy is decelerating sharply as capital outflows gather pace, in light of the growing Ukraine tensions, according to the IMF report. Russian economy is now expected to grow just 0.2 percent. 

With respect to other emerging markets economies the falling demand for their exports, notably from China and the US is having a knock on effect on their projected economic growth for 2014. Economic growth for emerging economies has been revised down to 4.6 percent for this year, down from previous estimate of 4.8 percent.

However, one relatively bright spot is Britain. Growth forecast figures have been revised upwards for 2014 to 3.2 percent, which is up from 1.7 percent a year earlier. The latest April-June Gross Domestic Product (GDP) figures were also relatively cheerful showing GDP expanding by 0.8 percent during that period. The countries service sector expanded by 1 percent in the second quarter of the previous three months. However, manufacturing barely registered an increase to just 0.2 percent and construction activity fell to 0.5 percent during the period April to June. While Britain’s economy is now larger than it was when 2008 financial crisis hit industrial output and construction are both still 10 percent smaller.

The recent IMF report recommends that advanced economies should not rush with monetary restrictive policies, the economic recovery if any is still too fragile. Moreover, the report highlights the fact that geopolitical concerns are more prevalent now than back in April. Particular reference is made to the Ukraine crisis and tensions in the Middle East that could have adverse knock on effects on energy input costs.

Overall the July IMF World Output report errs on the side of caution, underscoring potential black swans in the economy. For Britain the IMF report is flattering, but whether this upward trajectory in the economy can be maintained remains to be seen. If the IMF forecast is accurate, then there is likely to be little upside for British exporters. Additionally, domestic demand is expected to remain sluggish, in a climate of stagnant/falling real wages. How this all pans out is anyone guess, but it does feel like this calm in the markets won’t last for long and being on the right side of the volatility is what it’s all about.

MPC Meeting

All eyes will be on The Monetary Policy Committee’s (MPC) interest rate setting meeting, which is scheduled for today, August 6. The market is anxiously trying to gauge whether UK interest, which have been held at historic lows of 0.5 percent for the longest period in history, are going to rise either sooner, say towards the end of 2014 or sometime later in 2015. Certainly, yesterday’s release of the UK’s Purchasing Managers Index (PMI) survey, which exceeded all expectations comes as a relief for those traders betting on a rate rise before the end of the year.

Yesterday’s PMI, an economic indicator derived from monthly surveys of private sector companies, was bullish at 59.1 percent, bearing in mind that a figure of 50 percent indicates a cutoff level separating expanding from contracting services. So the latest PMI indicator suggests that the trajectory for UK service industry is both upwards and momentous. Indeed, Britain’s service sector was stronger than expected in July, with activity rising at the fastest rate in eight months according to the Markit/CIPS PMI. 

The service sector amounts to more than 75 percent of UK’s Gross Domestic Product (GDP) and it including hotels, bars, restaurants, IT, transport and business services. Such an upbeat PMI data is further evidence that the UK’s economic recovery is gaining traction. The PMI data follows the UK’s April-June Gross Domestic Product (GDP) which showed GDP expanding by 0.8 percent during that period. Reaction on the foreign exchange markets was predictable with the pound rising against the dollar and the euro after the survey was published. 

Interest rate hawks are now screeching louder for rate hikes. Many investors/traders are now wondering, in view of the recent upbeat economic data, whether these calls for a spike in rates has now finally gained the ears of the MPC. To date the Bank of England’s MPC has unanimously voted for interest rates to remain pegged at 0.5 percent.

However, while the latest PMI figures are upbeat it may actually be a red herring for the MPC when weighing up whether to go with the interest rate hawks and raise rates. It’s worth mentioning that the PMI is merely a survey, which doesn’t amount to any official economic data. Indeed, the survey is not totally comprehensive as it excludes retailing, energy and government-provided services. Moreover, in recent times it also tended to point to rather stronger growth than the official data from the Office for National Statistics (ONS). 

Nevertheless, assuming the MPC weighs heavy on the bullish PMI survey, they may have good reason to do so this time around since it is in harmony with April-June GDP figures showing an expansion of 0.8 percent. But the UK economic recovery is patchy. For example, manufacturing barely registered an increase to just 0.2 percent and construction activity fell to 0.5 percent during the same period. Moreover, both Industrial output and construction are down by 10 percent respectively, since the financial crisis. If MPC decides to set interest rates above 0.5 percent towards the latter part of 2014 the impact on already these struggling sectors would be adverse. Higher interest rate for industrial manufacturing implies higher investment costs as the cost of borrowing is increased. Furthermore, higher interest rates trigger a flight of “hot money,” speculative money into the pound, thereby appreciating its value against a basket of other currencies. The appreciating pound make it increasingly more difficult for UK manufactures to sell overseas, hitting exports as UK manufactured goods become more expensive and less competitive in foreign markets. 

The latest June UK British Industrial Output figure underscores the problems, output for industry as a whole rose 0.3 percent in June, lagging a forecast of 0.6 percent, according to ONS. Industry continues to struggle following the financial crisis 2008 and a further appreciation in the pound, brought about by higher interest rates would further hamper UK exports.

To some extent the bullish PMI survey is a double edged sword for the MPC because it highlights the growing problem of an unbalanced recovery in the UK economy and the complications of implementing monetary policy in such an economic environment. 

On the one hand an excessive lengthy period of low interest rates might be fueling a speculative bubble in equity, bonds and property price creating inflation in certain sectors of the economy, but to raise interest rates now would clobber the already feeble UK industry output. It’s a complicated situation-what is good for the goose isn’t good for the gander.

For too long policy makers have wrongly believed that as advanced economies matured and developed there would be a natural transition from the manufacturing sector to services. Every economic powerhouse today, Germany, USA, Japan, China has manufacturing as the backbone of their economy. It is the manufacturing that should drive the economy, which then results in a demand for services and not the other way around. Outsourcing manufacturing to China has not only resulted in technological transfers, which has directly damaged the manufacturing sector in developed economies, but it has also indirectly damaged the service sector too. As developing economies strengthen their manufacturing sector, they also develop their own service sectors, banking, insurance etc and leave developed economies in the cold. Maybe this is why Former US Treasury Secretary Larry Summers believes that there is a , “long-term, “secular” stagnation of the developed economies.”

MPC will no doubt be gauging the adverse effects that rate hikes could have on UK industry. Perhaps the hawkish screeches for interest rate rises might just be all in vain. Time will tell.

Friday, 1 August 2014

The Shanghai – Hong Kong Stock Connect

The Chinese market has been a difficult market for Western institutional investors to participate in and individuals have been, effectively, barred from investing in shares but the authorities are gradually opening up their markets in an effort to normalise transactions and to get better access to capital. The Shanghai – Hong Kong Stock Connect scheme is another significant step towards doing just that.

The Scheme is a’market’ which is designed to allow Hong Kong investors both institutional and high net worth individuals who have at least RMB500,000 ($80,000) to trade shares in Mainland Chinese companies and for Chinese investors to access overseas company shares through the Hong Kong market. It will have its own exchange and clearing house in the local market. Chinese Investors will have to meet certain criteria to be able to invest in the constituents of the Hang Seng LargeCap Index and the Hang Seng Composite MidCap Index and all H shares in the indices which have a corresponding A share listed in Shanghai.

The Scheme also allows Hong Kong and international investors to trade eligible shares in Shanghai. These will be constituents of the SSE 180 Index and SSE 380 Index plus any shares not in these indices but which have corresponding shares listed and traded in Hong Kong. 

The Scheme is designed to achieve the full benefits of a free and open trading market while maintaining adequate risk management controls and enjoying full government support. All trades will be done in Renminbi and the government hopes that the expected flow of the currency will provide a healthy and significant offshore system and should be a step towards the internationalisation of the Chinese currency.

The Chinese have accepted that their companies will have to meet the listing requirements and standards of reporting in Hong Kong before being traded there and will regulate them to that end. Both exchanges will share the revenue generated and will have the same rights and obligations so that both sides have a huge incentive to cooperate thus ensuring that the home investors are adequately protected against market misconduct in the originating market. Total trades will be subject to a maximum daily quota so that trades will be dealt on a first come first served basis. When the scheme has settled in, these restrictions are expected to be phased out.

The introduction of this scheme in the autumn of this year will ensure that Hong Kong is the centre by which China enters the international financial arena. It will enable Mainland investors to gain a wider diversification in their portfolios and will enable international investors to gain direct access to Mainland companies.

The scheme has been received with enthusiasm in China and Hong Kong. Currently, 90 brokers or 91% of those that are eligible in Mainland China have applied to join the pilot programme. There are also 215 or 43% of eligible Hong Kong brokers that have applied for the programme.

Chinese investors in stocks on the Hong Kong exchange will have to pay stamp duty on the transactions but should not be subjected to other Hong Kong taxes. Currently, they are exempt from paying Individual Income Tax on the disposal gains of shares listed in Shanghai and Shenzhen and through the Qualified Domestic Institutional Investor Scheme when investing in Hong Kong. It is not yet clear that the same will apply on the disposal gains and dividend receipts of overseas stocks. 

For overseas investors in Chinese A shares it is not clear whether or not the taxation rules which have applied to institutional investors that have had limited access to the A shares through the Qualified Foreign Institutional Investor Programme currently will apply under the Scheme. Under these rules dividend income and disposal gains are subject to Chinese income tax as it applies to corporates and investment income tax as it applies to individuals. It is also not clear if withholding tax will apply as the shares will be held in a nominee name within the Hong Kong clearing company. All these issues are yet to be resolved ahead of the expected launch in October this year.

The main reason for the introduction of this scheme is to widen the internationalisation of the Renminbi. As the second largest economy in the world and likely to be the largest in a few year’s time the currency should be easily used for trade outside of China. The currency is managed by the Chinese authorities to be maintained within a narrow range against the Dollar and this is unlikely to be changed in the short term as it allows for the currency to be managed to the benefit of China. This action gives the currency gradual exposure to the impact of the market without taking away this control. For individuals within China it gives them the ability to gain exposure to assets outside China.

For overseas investors this action will enable those who manage a Chinese portfolio to gain wider coverage, a more directly diverse portfolio with the knowledge that they can be confident in the standards of reporting and corporate governance that they understand is there. High net worth individuals will also be able to gain direct exposure to individual companies in China.

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