I am lucky enough to be a voracious and fast reader. The two magazines that I read every week are The Economist Magazine and the New Yorker Magazine. The one newspaper that I read every morning and every evening is the online edition of the New York Times. As I mentioned in the last market letter there are two articles that would like to talk about 1) is an article about income inequality and its possible effect on the future and 2) article on nuclear proliferation and how the current Iranian negotiations are critical. My comments will follow and will be seen above under the POST heading INCOME INEQUALITY AND NUCLEAR PROLIFERATION. But first let’s get an update on some current events.
Russia continues in the news, as the Russian economy continues to contract. In January, their prediction was minus 3% and now the latest prediction is that the economy of Russia will shrink between 3.5 and 4% 2015. The ruble has plunged 40% against the dollar in the last six months but has lately stabilized. This has allowed the Russian central bank to reduce their interest rates from 17% to 14%, highlighting the dire state of the country’s economy. The Bank of Russia is caught in a bind, inflation is soaring at 16.7% in February and food prices have jumped by 23% compared to last year. Cutting rates could push prices even higher, but leaving them at elevated levels may mean an even deeper and longer recession.
In China the Kaisa real estate company appears to be in trouble. The reason I mention this, is because I believe it is indicative of the stress many companies are having throughout the world and will have problems paying back their bonds or even being able to keep up the interest rates. Crediting Swiss borrowed $300 million to Kaisa in 2009. Then the company went public and raised other $450 million and embarked on an aggressive expansion into 20 more Chinese cities. Now, with the real estate market in China slumping, developers are under pressure investments and dry up. The company’s chairman Mr.Guo, has resigned due to health problems. Kaisa is now pushing for bondholders to accept 50% of the value of their holdings or risk getting pennies on the dollar is bankrupt. The Kaisa story is a window into what can go wrong investors rush into China, where profits have been tempting and warning signs such as complex corporate structures, opaque deals, and political influence has gone unheeded. Chinese authorities have just put a freeze on the sale of all Kaisa properties. A big warning sign!
In Europe, the DAX index has gone up approximately 11% in anticipation of national central banks begin their quantitative buying of bonds and a monthly rate of $60 billion euro. With interest rates effectively as zero, the ECB hopes to push down bond yields and push prices up. The idea is to lower borrowing costs across Europe, not just for the government, but for households and businesses. The 10 year government bond in Germany, now just yields .03% and the German five year bond is in negative territory along with other European countries bonds. The euro has slumped approximately 10% against the dollar in 2015, to trade at 11 year low and may be heading for parity. That has twin benefits of making European exports cheaper on the world markets and driving up the cost of imports which have been falling for first three straight months. Cheaper money is also pushing investors into the stock market in search of better returns. There are as many negative factors for quantitative easing is there are positive factors. Although increases existing bailout program for Greece was extended by four months to the end of June, it appears unlikely that Greece will meet the European central banks demands for austerity. This is just kicking the can down the road for future problems.
On Wall Street, volatility is back with a vengeance. The Volatility Index is up 5% this week and 20% this month. To blame has been plunging oil prices back to $45 a barrel and the resurgent US dollar. The strength of the dollar has driven the euro to a 12 year low. A stronger US dollar should hurt profits of big multinational companies that generate a big chunk of their sales overse,as these companies are hit two ways. International sales are lower once they are translated from weaker currencies back into American dollars and a robust dollar makes it harder for US companies to compete abroad. The price for European and Japanese goods are going to be cheaper than American exports. While lower oil prices should be great news for consumers, consumers do not appear to be taking advantage of lower prices. Very unexpectedly, retail sales have fallen for the last three months. The last time this happened was July through September 2008. We all know what happened next. Consumers may also just being thrifty. The savings rate is at a 5.5% level in January, the highest level since December 2012. The good news this week was the bank stress tests conducted by the Federal Reserve indicated we don’t have to worry about bank balance sheets. As I said in the last market letter, you can believe that I’ve got a bridge in Brooklyn I can sell you. The government does not like to give out bad news and denied such things as lead in paint and gasoline were a problem, that nuclear testing did not create harmful radiation, that nicotine does not cause lung cancer and that there is no direct relationship between CO2 levels and global warming. Be skeptical!