The new China direction - inward

Comments from Lou Jiwei, chairman of CIC, the SWF of China, suggests that the focus of China will be inward. "If China can do a good job domestically that is the best thing it can do for the world" We should not expect China to use its large wealth build-up to save the West.

However, increased consumption in China will be good for the global economy. Lending rates have been cut four time since mid-September. A massive fiscal spending policy has also been announced. Nevertheless, it may not be a big factor in 2009. Internal growth has to substitute for the export revenues of the last decade but changing consumer behavior will take time. Export firms on the China coast have been devastated with declines in orders. We can see the fall-off in global exports when you look at the Baltic freight rates, off over 90% from highs.

The currency has also stopped appreciating and has actually seen a reversal in the last few days. A similar slowdown occurred last year after the credit crisis problems in August. Do not expect any currency appreciation anytime soon. China is going to follow its own policies and not be swayed by the G7.

Something good from Wall Street – sell-side research is better

Analysts on the sell–side do a better job than buy-side analysts. A recent article in the summer 2008 issue of the Financial Analysts Journal finds that buy-side analysts are more optimistic than their sell-side brothers and sisters and generally do a poorer job then the sell-side, “Buy-side vs. Sell-side Analysts’ Earnings Forecasts” by Boris Groysberg, Paul Healy and Crag Chapman. Interesting! The sell-side is supposed to be in the bag with investment banks so there supposed to be overly optimistic about the stocks of clients which the banks have an economic interest in courting. The numbers prove otherwise with the sell-side being more accurate and less optimistic. Look at their earnings estimates and targets and not on the recommendations.

The researchers find that the pressure cooker of Wall Street forces analysts to do a better job. The best and worst on Wall Street are more likely to change jobs. The best move up the letter for better compensation and the worst are forced out of the business. The kinder and gentler buy-side is less willing to eliminate poor performers and may not be willing to pay for top analysts or those analysts get promoted to portfolio management jobs. The economic competitive story makes sense even if more decisions are made by portfolio managers. Now the sample is not for all buy-side analysts but this is an interesting counter-factual result from what may be expected.

A downsizing of Wall Street may actually create more market inefficiencies for those who are left standing. There will be less competitive research done on the street because there will be less analysts and less places for good analysis to move to. The buy–side will be more dependent on their research which may not be as good. There will also be less collaboration or competition between buy and sell-side analysts to provide the best ideas to the client, portfolio managers. Investors still need good research.

Fear, Liquidity and Ambiguity

Robert J. Samuelson, the columnist, suggests that fear is the cause of the stock market volatility.

“The stock market is nothing if not a psychological barometer. The present signal is unmistakable: fear. It's not just that the market dropped by more than half; that decline parallels some previous post-World War II bear markets (48 percent in 1973-74 and 49 percent in 2000-2002). More revealing are the day-to-day movements. From mid-September to Nov. 21, there were 50 trading days; on 25, the market moved 4 percent or more (16 down, nine up), reports Wilshire Associates. In the previous 25 years, there were just 25 daily moves of 4 percent or more. We've gone from one a year to one every other day.”

Fear can make everyone a seller but it does nothing to help buying. The markets are more complex. Even with strong volumes what may be missing is liquidity. The Option Industry Council reports that option trading while up 28% over last year is actually down 21% for November 208 versus November 2007. The NYSE volume for November was down to the lowest levels since December 2004. Volume is off from the high levels of 2007.

Lower trading could be associated with the uncertainty in the market. The result is less liquidity at any price so that there will be more distorted moves, higher volatility and strong down moves matched by quick reversals. The lower volume and liquidity means that there will be greater short-term price pressure effects. Large sell-off seen sell orders come into the market only to be reversed quickly later in the day or the next day. If there is less leveraging by dealers there will be a reduction in market-making. Dealers cannot house positions when there is a price pressure effect move. The greater volatility has a feedback effect. High volatility by itself causes more uncertainty and will reduce volume. If you cannot be certain on the price at execution, there will be less trading.

Ambiguity about policy and stock valuation will also reduce volume and cause a lowering of liquidity. Investors are not substituting one stock for another but moving to cash which withdraws liquidity.

Fear is not a precise term. A story of liquidity and uncertainty can better describe the poor market conditions currently being faced.

It's official the US is in a recession

The NBER recession dating committee met on Friday and have agreed that the economy peaked in December 2007, so we have been in a recession for just under a year. Now you could have asked a lot a people the same question and they would have answered this question a lot earlier.

Since there is not definitive means of determining the when we are in a recession we have to using a dating committee which looks at a number of criteria. The following story provides the official comments from the NBER with Q and A, http://www.usatoday.com/money/economy/2008-12-01-recession-nber-statement_N.htm

Should we feel and better or worse now that we have the recession dated? The one thing that is clear is that this recession is already longer than the average of past post-WWII recessions and will be of a magnitude at least as deep as the 1980-81 recession. At least we have a point of measure nd baiss for what needs to be done in terms of fiscal stimulus.