By Jim O’Neill, Chairman, Goldman Sachs Asset Management.
My week kicked off with a tough Monday start following the Rolling Stones concert Sunday night, but what a boost it gave me. Keith, Mick and the boys rocked on for two and a half hours. It really is quite an inspiration that such serious and serial partiers can perform like they do, at close to 70 years old. If that wasn’t enough, we then have the rather intriguing news of a non-British person becoming the next Bank of England Governor, which I think is rather cool too. More on this below.
As for the ongoing market issues and debates, I am not sure if this past week leaves us much the wiser on any of them, but here’s my latest take on them as well as the markets.
Japan and the yen.
After two weeks of a strong one-way move, the Yen has recovered a little this week. In parallel, a shift in mood is occurring with many starting to say that even if he becomes PM, Abe won’t be supported by an LDP (Liberal Democratic Party) majority and, in any case, is backing off from the more aggressive aspects of his previous stance.
I don’t really share this mood shift. As I discussed with an investor on Thursday, the core issue is really whether in the future, the Bank of Japan follows an inflation “target” or a “goal”. This is crucial and, according to what I pick up, I think it is going to become more of a target. Whether Abe is supported by an LDP majority or not, I think this will happen. As I reported last week, I believe it could well be a 2% target. If this is indeed what is likely to transpire, this is the “missing link” in what is, from a non-monetary perspective, already a growing Yen bear case. In my view, significant overvaluation, deteriorating balance of payments, and now a probable major shift in the style of monetary policy, make a compelling case.
As I also discussed last week, what might shift this from being simply an interesting investment idea ($/Yen 88-90, for example) to something much bigger, is if this coincides with a shift in the US stance too. I believe Bernanke’s comment last week about the trend growth rate which “might have” been lower than he previously thought, must at a minimum mean he is not so confident about the trend rate going forward. Additionally, if the US economy continues to grow by 2% to 2.5% (2.7% after Q3 revision) and unless inflation eases notably, the Fed can no longer be so convinced about QE and the path to 2015 that they recently adopted. Anyhow, it seems to me that if the pre build-up to the election is all just a fake hope, then the Yen will end up strengthening again for a while, perhaps back to the level of Yen 78-79. However, if Abe gets part of his way, I believe it could head to Yen 88-90 levels. And, if the US positively surprises going into Q1 2013, it might even be setting the scene for a move to Yen 100-120 levels.
This past week, the local China A-share market has continued to weaken, and indeed, the weakness has accelerated on the break below the 2,000-point level. So much for it being cheap! At the same time, many other China related plays are doing ok, so what is happening? Do the locals know something the rest of us don’t, or is it just negative sentiment and/or is there anything technical going on? I have spent many hours thinking about this and discussing it with people this week, and I don’t know the answer. However, as I have mentioned before, I suspect that what is going on is that this discrepancy is a function of the shift from “quantity” to “quality” in China. Additionally, by definition the A-share index is dominated by the winners of the past, and since China is changing and there are going to be new winners and losers, you are not going to see this in an index which reflects the past. What is also clear to me is that most useful indicators do suggest that China’s economy has, at least so far, strengthened into Q4. Leading indicators suggest as well that there is no reason to fear this is just a one or two-month thing as I hear many suspect.
Various bits and pieces of vague interest in Europe this week, but nothing particularly eye-catching in my view.
Greece had yet another “deal” done regarding its debt-restructuring and, with the amount of media attention it has received, anyone might think it is the most important topic in the world. But it is not. Remember when David Cameron mentioned China creates the equivalent of another Greece every three months, or is it 11 weeks these days?
Interestingly, there is a theory that once the payment of Greek debt was rescheduled, this would also open the doors for Spain to finally formally seek support from the ECB, especially if it coincides with the Catalonian election. As I remarked to many people weeks ago, one of the reasons why the ECB support was neither requested nor encouraged at the time, might be because, if the worst with regards to Catalonian separatism had happened a few weeks later, it would not have been wise to rush. And, goes the theory, the German leadership only wants to go back to its parliament a limited number of times, so why not combine them both? This makes some sense to me, so it is possible this theory becomes reality.
It is, of course also possible, that people are slowly but surely noticing that Spain and a number of the other “Club-Med” countries are showing evidence of structural change, and therefore don’t need any official support. This could be because the market is starting to take relatively more notice of this than of the discussions about the US fiscal cliff. An interesting report from the Lisbon Council highlighted some of the better things this week.
All this said, the French aspect to the EMU woes continues to occupy more of my thoughts, not least after the latest worrying rise in their unemployment rate and, of course, the problems facing ArcellorMittal. But what is also just as interesting is that none of these French woes seem to be negatively affecting the markets much yet.
Other bits and pieces.
The US fiscal-cliff topic remains front and centre of most people’s daily chatter and focus. I am not sure I have much to add or offer on this, other than it would be quite remarkable if no deal is agreed. If this isn’t the case, we are told to expect one soon after the deadline, if it is not met by then.
UK miracles and the Bank of England.
So, last Monday, the UK Chancellor stole the world’s attention by announcing the news that Mark Carney is to become the next Bank of England Governor. This certainly surprised the bookies, if not everyone. I find myself joining the “Admiration Society” regarding this move, not because I think Mark is going to solve every challenge the UK has ever experienced and will ever face, but simply because it is different, slightly daring, a bit anti-establishment, without being too risky, since he has lots of experience. And, perhaps this will turn out not to be the case, but it seems like a bit of a shake-up call.
What it will bring, we shall see, and it is still a long way off until he starts his leadership. As I have opined occasionally in the past, one aspect which I think is worthy of more attention is that from a policy perspective, inflation-targeting in the UK has turned out to be a necessary policy goal, albeit not sufficient on its own for the Bank. I believe that they should also follow some sort of modern version of a Financial Conditions Index (FCI) which could include various banking indicators, house prices, etc as an important secondary indicator. There was a period when the Bank of Canada actually targeted their version of an FCI as their policy goal, and while it predates Mark, I think it is obviously something he will be more than familiar with. I think this would be helpful in the UK, and would provide the framework for the new Financial Policy Committee or whatever it is to be called. It would also help to remove this rather odd notion that in the future the Bank of England cannot be led by only one person, due to the depth and breadth of responsibilities. Isn’t this a piece of cake compared with being a Prime Minister or President?
I attended an event to celebrate the anniversary of probably the world’s longest existing Sovereign Wealth Fund this week and it was interesting to chat with some of their team and guests. It left me thinking that, in this frantic world of newswire and regulatory overload, many similar organisations have a natural advantage where they can, if they are so structured, take advantage of the best underlying opportunities, and if they so choose, can genuinely think longer term. This also led me once more to thinking about today’s very high level of the so-called Equity Risk Premium (ERP) and why it seems to me quite compelling to be bullish still for equities even if the geographic leadership might shift from the US to elsewhere in the world as 2012 moves into 2013. Of course, if the Bank of Japan does the decent thing, this may include Japan leading the so-called developed world along with some of our Mediterranean friends.
Good luck out there.