The simple story is this: We believe the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyze a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over.
In meetings with strategic allies and clients throughout October, we began emphasizing our growing concerns about the nearly ubiquitous confidence the financial markets — and for that matter, global leaders and their body politic — have in China; and by extension, the rest of the emerging market story, commodities, and the long-term direction of foreign exchange cross-rates.
Not surprisingly, our concerns were met with varying degrees of resistance; but the overall consensus clearly favoured a very bullish, asymmetric outcome over both the near and intermediate terms. When pressed as to our own sense of timing and specific catalysts for broad-based trend reversal, candidly we were unclear. Our sense then was that the higher and faster the commodity markets pushed, the sooner the reversal would occur. But we have now clarified our view.
In just the past several weeks, we believe the data and government action out of China, the back-up in US interest rates, intensifying pressures across the EU, broadly rising commodity prices, intensifying efforts to control hot money flows, and the market’s strengthening belief that somehow China and the United States would be able to engineer and a currency re-alignment without breaking the global growth story, have finally pushed the global terms of trade to their tipping point.
And now, as is evident by the flight to safety, and growing evidence that China will soon try and effect price controls in addition to raising interest rates and significantly changing the rules for their vast network of TLGVs, the writing is on the wall. The game is over.
The simple story is this: We believe both the structural and cyclical terms of global trade have reached their tipping point which will effect a wholesale change in sentiment and a historic repositioning of risk assets.
So what do we consider the “terms of global trade”?
Structurally, they are the intersection of:
A. Government Policy (rule of law, market systems, trade law, etc);
B. Resource and Industry (natural resources, labor/demographic pools, industrial advantages, import dependencies, etc); and
C. Economic Security (sovereign’s competitive standing, the relative power/needs of the citizenry, the mandate/control of the government, etc.)
And cyclically, the terms of trade are defined by the intersection of foreign exchange rates, commodity prices, and the cost and availability of trade finance. And in our assessment given:
1. The structural breakdown of the credit and labour markets in the developed world and the anaemic outlook for nominal GDP growth;
2. The immaturity of the developing world and their vulnerability to credit shocks and uncontrollable inflation;
3. China’s dependence upon non-economic, and unsustainable credit expansion to maintain growth far beyond natural export and domestic demand; and
4. Asia’s dependence upon imported energy and agriculture:
the game is over!
Presently, we believe that the broad-based resurgence of investor confidence in the emerging market and secular bull market in commodities will end badly; proving that the rally which commenced in Q2 2009, was in fact an “echo bubble” facilitated by massive — and unsustainable — stimuli from the Chinese Government.
And although such cataclysmic shocks rarely result in rhythmic, straight line fractures, the chain of price adjustments should be relatively clear. Accordingly, we expect a shockingly powerful rally in the dollar, broad-based weakness across the commodity sector, a dramatic widening of emerging market credit spreads, and what could prove to be a stampede of hot fund flows out of the emerging markets.
We appreciate both the gravity and the brevity of this note; but then again, the story is simple!
a fuller version of this thesis is here
U.S. Wins, Says, Mark Lapolla, But Future To See Very Little Growth