Not bad for our little newsletter… On June 19th, we published this list of 12 bullish trade ideas on the Dow in the weekend edition of Stock World Weekly that are already up $6,720 in just two weeks!… Phil called for cash on Friday, so short-term bullish plays like these were taken off the table as we flirt with potential disaster next week.
While the media has been focusing on Europe, especially Greece, much of the rest of the world is also troubled. Unrest in the Middle East continues. Protests and violence in Syria have been escalating. On Friday, over 400,000 people gathered for a huge demonstration in Hama to demand the ouster of Assad and his government. Syrian forces killed 28 civilians, according to the AFP news agency. (Syrian state TV says Hama governor sacked)
Japan is still struggling in the aftermath of the massive March 11 disaster. The government began imposing restrictions on energy consumption by companies, shopping malls and other major energy users. In trying to deal with widespread energy shortages after losing the Fukushima Dai-ichi nuclear power complex, it has limited the use of lighting and air conditioning in public areas and launched a campaign urging office workers to give up their traditional business suits and ties in favour of cooler wear, such as tee-shirts and polo shirts. Temperatures in Tokyo often exceed 100 degrees Fahrenheit during the summer. (Japan limits energy use as disaster causes crunch)
The Ministry of Economy, Trade and Industry announced that Japan’s industrial production rose 5.7% in May, spurred by a rebound in auto output. Marketwatch reported, “Among forecasts contained in the government data, manufacturers tipped a further 5.3% gain for June, down from a previous forecast of 7.7%, and a sharp slowing in July, when they said output would rise just 0.5%.” (Japan’s industrial production jumps 5.7% in May) The expectation of slowing in July conforms to the results from the latest report from the Bank of Japan’s quarterly Tankan poll of thousands of Japanese companies. The report showed that sentiment among large manufacturers had dropped dramatically from a reading of +6 in March down to negative 9 in June. (Poll Finds Confidence Down in Japan)
The People’s Bank of China raised the reserve requirement ratio by 50 basis points to 21.5%, the sixth increase this year, as the government battles inflation. China’s official manufacturing PMI reading was down from May’s reading of 52.0 to 50.9 in June. The manufacturing sector has been slowing for three consecutive months. Bank of America Merrill Lynch economist Lu Ting remarked, “This lower-than-expected PMI reading will further depress markets which have been increasingly worried about a hard landing in China in the past two months. Some policy makers might also be more concerned about over-tightening and might consider slightly easing their policy stances.” (Tokyo, Seoul extend gains, but Sydney retreats)
The Financial Times reported that small Chinese businesses are feeling the effects of the government’s monetary tightening and are facing a cash squeeze that may be worse than during the 2008 global financial crisis. “Dong Tao, a Credit Suisse economist, said China could now face trouble again, as companies delay bill payments and factory owners abscond without paying wages. ‘If this continues, and these smaller companies start to fail in large numbers, then the economy will slow more than the market anticipated and the government bargained for,’ he said.” One possible consequence would be a repeat of the events of 2008, when small and medium enterprises (SMEs) suddenly closed without warning. The prospect of hordes of unpaid factory workers protesting in the streets greatly concerns the Chinese government, which is wary of anything that could spark social unrest. (China’s SMEs face severe cash crunch)
Michael Pettis, author of the China Financial Markets blog, reported that government efforts to combat inflation are having a negative affect on China’s economy. According to Michael,
“Rebalancing in the context of China means, for the most part, a significant increase in the consumption share of GDP from its astonishingly low level of 35% in 2009 (and perhaps lower last year). As regular readers know, I do not believe that China’s high savings and low consumption rates are a function of any remarkable preference on the part of Chinese households for savings over consumption.
“They are simply the automatic consequence of a system in which increases in GDP growth are subsidized by transfers from the household sector, which effectively constrains the relative growth of household income and, with it, household consumption. In that case the only way for China to rebalance would be for Chinese household income to grow faster than GDP. This requires three things above all. It requires that wages grow faster than productivity, that the currency appreciates, and that real interest rates rise. This does not seem to be happening in China, as I discussed in a blog entry last month…
“In the aggregate the impact on the growth of the household income share of GDP is probably negative, at least if the World Bank is correct in saying that consumption growth has been actually declining since early last year (and as Tuesday’s retail sales data seem to confirm). But this uneven rebalancing has another impact, I argued. If wages are rising and the cost of capital is declining, we should be seeing a shift internally in favour of capital-intensive industries, the SOE sector, for example, and away from labour-intensive industries, which includes SMEs for the most part.
“I had anecdotal evidence corroborating the theory. Since last year several of my students who come from manufacturing families had told me that their parents were finding it increasingly difficult to retain workers and were getting squeezed out of business. Two months ago my central-bank-seminar student Huang Haidong, who comes from a prominent Wenzhou family (Wenzhou is often considered the cradle of the SME industry in China), sent me an email saying that according to his research a very large number of Wenzhou SMEs were facing bankruptcy…
“Whatever the outcome I think we need to keep a close eye on the behaviour of SMEs. They are by far the most efficient part of the Chinese economy and the only part creating real value. My experience in other developing countries suggest that SME owners tend to be the most sensitive to and aware of changes in risk, and if we start to see rising bankruptcies among SMEs, coupled with disinvestment and increasing capital outflows, that is almost always a very worrying sign. When SME owners start to worry, so should we.” (Small companies feel the pain in China)
On our financial markets, Lee Adler of Wall Street Examiner writes
“The market followed through on the upside celebrating the last day of QE POMO. I’m sure that the move was based totally on the great economic and liquidity fundamentals and had nothing to do with month end tape painting and a short squeeze of bears like me who had so wisely piled in on the short side lately. No. Nothing at all…
“The Primary Dealers finally had a payday on their enormous Treasury short position. They got help from foreign central banks, who, if the horrible indirect bid at this week’s auctions is any indication, stayed away from the auctions in droves. The biggest deal is the collapse of the indirect bid. This may be the first real sign of capital flight away from US government debt. The fact that a lot of cash flowed into stocks (the next safe haven?) is not comforting. In fact, it’s insane, but we shouldn’t stand in the way of it. No one here needs to be disabused of the notion that markets can stay irrational longer than you can stay solvent. However, I do think that there’s a hard limit out there. If cash is leaving the US market and the Fed isn’t printing, a stock market rally cannot be sustained indefinitely. And today, the Fed stopped printing.
“The tax data as June drew to a close continued to show weakness versus last month and last year, suggesting that the US has already entered the second leg of this economic depression, and it will only get worse without the support of QE, and with more budget cuts certain to lie ahead.
“The Treasury will announce an updated estimate for 3rd quarter funding on August 1. Look for a huge shock when they announce just how much more debt the gummit will need to sell compared to what was originally estimated for the quarter. Mark that date on your calendar.” (Wall Street Examiner )
In other news, the bizarre sexual assault case against Dominique Strauss-Kahn appears to be collapsing, ironically lending credence to conspiracy-type theories. DSK’s accuser, the hotel housekeeper, lost credibility during the prosecutors’ investigations and DSK was released from house arrest on Friday. The NY Times reported that case against him is moving towards dismissal. (Strauss-Kahn is released as case teeters.)
We have four trade ideas this week, two long and two short. These are meant to be part of a balanced portfolio. At Phil’s Stock World, Phil’s current asset allocation is still 15% bearish, 20% bullish and 65% cash. While our long-term outlook remains bullish, our near-term outlook has turned more bearish.
Just as the legal outlook for ex-International Monetary Fund chief Dominique Strauss-Kahn started looking brighter in the U.S. with news prosecutors’ case against him for sexual assault may not get to a court, DSK’s horizon seriously darkened back in France. On Monday, as various signs accumulated suggesting his political career in France may well be kaput even if he escapes trial in New York, media reports revealed a French woman who says Strauss-Kahn attacked her in 2002 will be filing rape charges against him in Paris Tuesday…