Throwing Cold Water On Investor Optimism (Not That We Needed Too)

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From The Geneva Report

Yesterday the 16th Geneva Report was released bearing bad news for everybody that was hoping for good news. The report, which highlighted that debt across the planet had continued to increase  and speed up despite the market crash of 2008, is sobering and seemed to cast in stone that which we already knew; that the global recovery is slow going and still looks very anemic.

The report is detailed and well over a hundred pages and only came out yesterday, so don’t be surprised if all the news reports you read about it really only cover the first two chapters and the executive summary. What is interesting about the report is how little of it we didn’t know. Much of what the report covers (and in great detail at that) is that the Eurozone is still weak, that the Federal Reserve has lots of debt on its balance sheets, but that it has helped turn the US

A look at the Fed's Balance Sheet from the Geneva Report
A look at the Fed’s Balance Sheet from the Geneva Report

economy around, that governments have been borrowing more while companies and individuals borrow less, and that economic growth in the Emerging Markets has been accompanied by considerable borrowing. All of this we knew.

What stands out to me in this report are two things that I believe should matter to Canadian investors. First is the trouble with low interest rates. Governments are being forced to keep interest rates low, and they are doing that because raising rates usually means less economic growth. But as growth rates have been weak, nobody wants to raise rates. This leads to a Catch-22 where governments are having to take direct measures to curb borrowing because rates are low, because they can’t raise rates to curb borrowing.

This has already happened in Canada, where the Bank of Canada’s low lending rate has helped keep housing prices high, mortgage rates down and debt levels soaring. To combat this the government has attempted to change the minimal borrowing requirements for homes, but it hasn’t done much to curb the growing concern that there is a housing bubble.

The second is the idea of “Economic Miracles” which tend to be wildly overblown and inevitably lead to the same economic mess of overly enthusiastic investors dumping increasingly dangerous amounts of money into economies that don’t deserve it just to watch the whole thing come crashing down. Economic miracles include everything from Tulip Bulbs and South Sea Bubbles to the “Spanish Miracle” and “Asian Tigers”, all of which ended badly.

The rise of the BRIC nations and the recent focus on the Frontier Markets should invite some of the same scrutiny, as overly-eager investors begin trying to fuel growth in Emerging Markets through lending and direct investment, even in the face of some concerning realities. It’s telling that the Financial Times reported both the Geneva Report on the same day that the London Stock Exchange was looking to pursue more African company listings, even as corruption and corporate governance come into serious question.

All of this should not dissuade investors from the markets, but it should be seen as a reminder about the benefits of diversification and it’s importance in a portfolio. It is often tempting to let bad news ruin an investment plan, but as is so often the case emotional investing is bad investing.

I’ve added an investment piece from CI Investments which has been floating around for years. It pairs the level of the Dow Jones Industrial Average  with whatever bad news was dominating the market that year. It’s a good way to look at how doom and gloom rarely had much to do with how the market ultimately performed. Have a look by kicking the link! I don’t want to Invest Flyer

 

***I’ve just seen that the Globe and Mail has reported on the Geneva Report with the tweet “Are we on the verge of another financial crisis” which is not really what the report outlines. 

Russia Invades Ukraine, Needs Potatoes

This Russian paratrooper crossed the Ukrainian border “by accident”

Last week it looked as though Russia was escalating its engagement in Ukraine, sending supplies directly into Ukrainian territory and potentially starting a full blown war. But things have remained opaque since then, with increasing reports that Russian troops were crossing the border and Russia steadfastly denying it. But after days of reports from the Ukraine that Russia had started a low level invasion to assist with Pro-Russian forces, CNN reports this morning that Russia is now using tanks and armoured personal carriers and is fighting on two fronts within the Ukraine.

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Whether this proves to be a false start, or if Russia is going to become more open in its military involvement it’s hard to say. What is clear is that this war in Ukraine is far from over.

Meanwhile this week also saw some evidence about the rising cost of food in Russia as a result of the retaliatory trade restrictions directed at nations like the United States, Canada and most of Europe. Reported in Slate and Vox.com, this graph of rising food costs is actually quite surprising. Potato prices have risen by 73%!

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I’m reluctant to say too much about this situation and what it means from an investor standpoint, lest people think I am taking the suffering of people in a war zone too lightly.  I will say that as emerging market countries become richer and begin to flex their national muscles, jostling over everything from important natural resources, long disputed borders, and sometimes even national approval, its likely that international events could increasingly be outside of our control. Since much of our manufacturing is now outside of our borders, and often even energy supplies come from nations openly hostile to us, we find ourselves in an economic trap of our own making. How can you act with a free hand against a nation that holds so many of your own economic interests?

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From “The Economist” July 27th, 2013 “When Giants Slow Down”

I sincerely doubt that our sanctions against Russia or high potato prices will bring Putin to his knees, (although his people may get fed up with higher food costs) but in the past it was much clearer how to deal with this kind of brinkmanship. Today we live a world where many of our economic interests are heavily tangled with nations who do not share our same strategic goals. It is said that nations do not have friends, only interests, and as Emerging Markets look increasingly attractive to foreign investors we may have to remind ourselves that Emerging Markets are not simply opportunities for growth, but nations with their own set of interests and goals separate from our own.

Russia’s Trade War Shows Europe to be The Better Economy

Putin-SmirkSince I first wrote about the Ukraine much has happened. Russia has been unmasked as a bizarre cartoon villain seemingly hellbent on destabilizing the Ukrainian government, assisting “rebels” and being indirectly responsible for the murder of a plane full of people. All of which came to a head last week when it appeared that Russia might have just started a war with the Ukraine (still somewhat indeterminate).

Russia’s moves with the Ukraine may have more to do with challenging the West, and some of the other recent militaristic actions show that may be its real intent. Russia announced in July that it would be reopening both an arctic naval base and a listening post in Cuba built back in the 1960s. Combined with many heavy handed tactics at home including essentially banning homosexuality, Putin is making a brazen attempt to assert its regional dominance and stem the growth of Europe’s influence in the most aggressive way it can. To some extent this seems to be working with his own population, but it isn’t making him popular globally.

Europe’s response to Russia has been to hurt it with economic sanctions, which since the Ukrainian situation first began have been escalating in severity. Two weeks ago Russia responded in kind. How? By banning food imports from sanctioning nations.

If you don’t know much about the Russian or European economies this may seem like potent response from one of the BRIC countries and major global economies. But Europe is a big economy, and agricultural exports don’t make up a significant part of GDP, with the same being true for the United States. And while sanctions targeted at farms can be politically dangerous (farmers are typically a well organized and vocal lobby) the most interesting thing about these sanctions is what it tells us about the Russian and European economies respectively.

First, Russia imports a great deal of food, mostly from Denmark, Germany, the United States and Canada. So sanctions imposed by Russia are really going to hurt the Russians as food prices begin to rise and new food suppliers (expected to be from Latin America) have to ship food farther. But more interesting is the sanctions Russia chose not to impose. Europe is heavily dependant on oil & gas for its energy needs. So why not really make Europe feel the pinch and create an energy crisis? Because Russia needs oil revenue.

16% of Russia’s GDP is made up from the oil and gas sector. Beyond that oil and gas make up more than half of Russia’s tax revenues and 70% of it’s exports. In other words Russia can’t stop selling its oil without creating an economic crisis at home every bit as severe as in Europe. Banning imports of food and raising the cost of living may not be the ideal outcome from sanctions you impose, but it is mild in comparison to creating a full on catastrophe.

By comparison Europe starts to look very good, and it’s a reason that investors shouldn’t be quick to write off Europe and all its recent economic troubles. It’s a large and dynamic economy, filled with multi-national companies that do business the world over. It is backed by stable democracies and a relatively prosperous citizenry. By comparison Russia is a very narrow economy, dependent on one sector for its economic strength run by a (in all but name) dictator with an incredibly poor populace. A few years ago it was quite trendy in the business news to write off Europe as a top heavy financial mess, and while I wouldn’t want to dismiss Europe’s problems (some of which are quite serious) it’s important to have some perspective about how economies can rebound and which ones have the flexibility to recover.