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alternative investments in the world’s fastest growing markets
200
2008
Roman Scott Managing Director Calamander Group Economic Spokesman British Chamber of Commerce Singapore
Issue IV 09 April 2008
Calamander Capital Economic Outlook, Q2 2008
The Emperor Has No Clothes
9 April 2008
Economic Outlook Q2, 2008 Page 2
The Emperor Has No Clothes ‘Pessimism, when you get used to it, is just as agreeable as optimism’ - Arnold Bennett
-11.4
2.4
-17.5
-8.4
-2.8 -2.5
-13.8-11.8
-17.4
-19.3
-9.4
-20.0
-16.0
-22.7
-19.3
-4.7
-18.1 -17.3
-13.2
-4.1
-17.6
-25.0
-15.0
-5.0
5.0
World Bond
(Citi World
Bond)(Eurofirst
80)
(DJIA) (SPTSX) (SPI)
(Nikkei
225)
(FTSE
100)
(Shenzen
B share)
(SP CNX
Nifty)
(RTS)
(SET)
World
(MSCI) (STI)
% YTD
(Kospi)
(Composite)
(Composite)
(TAIEX)
(S&P300)
Source: Bloomberg; MSCI Barbarra, Smith Barney (Citi)
(CAC-40)
(DAX)(Bovespa)
Global market at a glance
lthough a few holdouts in the optimist camp remain, it does now appear that almost
everybody (central banks, economists, and investors) have finally caught up with the
reality - the US sub-prime debt can, and is, leading the US economy into recession.
Unfortunately, US businesses and consumers also appear to feel this way, leading to the
vicious circle of depression economics. As the perception that times may be getting harder
sets in, businesses curb investment and hiring and consumers keep a tighter hold on their
wallets, which in turn leads to reduced economic activity. Expectations turn into reality. For
‘the invisible hand’ of the free market system, confidence is everything.
At this point, however, the consensus departs. Whilst the pessimists view the current mix of
a slowing US, a banking crisis, and inflation as a major problem; most institutional and
government forecasts believe that any downturn will be short-lived. The aggressive easing
by the Federal Reserve certainly seems to have increased confidence despite questions over
the policy to support growth and control inflation. Bernanke has combined Greenspan’s
A
9 April 2008
Economic Outlook Q2, 2008 Page 3
‘throw them cheap money’ approach with an unprecedented fiscal commitment to bail out
any financial institution considered too large to fail. Even non-deposit taking ‘investment’
banks such as Bear Stearns appear to qualify, with over 30 billion dollars of taxpayers’
money devoted to its rescue. Therefore, it is not surprising that markets appear to have
stabilized in anticipation of a short lived ‘V’ shaped recovery. We are reminded of the
resilience of the US economy and consumer, and that US recessions since the war have
lasted on average only 10 months. Global growth, in this scenario, remains benign at about
4%, supported by the continued rapid expansion of Asia and the other BRIC economies,
even as Japan and Europe slow to a crawl but keep going.
0
1
2
3
4
5
6
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
F
%
y-o-y
Source: IMF
3.7%
Global GDP growth
Recent news that until recently would have taken markets further down have instead led to
relief rallies. Banks globally have written down over 2 billion, and the market appears to
think that the majority of the pain is over. We had previously in February this year
estimated that total writedowns would be over 500 billion, as the contagion effect in mark-
to-market values of Alt-A, and A-AAA grade debt is worked through the system. We also
stand by our estimate that the overall impact of impaired credits in the broader market,
including credit cards, autos and other prime debt, would total over a trillion dollars.
9 April 2008
Economic Outlook Q2, 2008 Page 4
Division players
3.9
3.7
3.4
3.3
3.3
3.2
3.1
3.1
3
2.8
2.6
Canadian banks (<1Bn) 2.5
2.5
2.4
2.3
1.9
1.7
1.7
1.5
1.4
Other banks (=<1.3)
Gulf international
Championship
9.1
8.7
8.2
European banks (<1Bn) 7.9
7.5
6.6
6.4
5.0
4.9
Asian banks (<1Bn) 4.7
4.1
Premier League
38
25.1
23.9
12.6
12.4
Total sub-prime writedowns/losses ~ USD 245Bn and counting…
UBS’s second 19 billion dollar write-down, an extraordinary amount of money to have
potentially lost by any measure, resulted in the stock going up 10% and global banks firming
in sympathy. Lehman Brothers, viewed as bearing more than a passing resemblance to the
now extinct Bear Stearns (excuse the pun), convinced investors to pony up 4 billion dollars
to shore up its capital base and avoid the same fate. Meanwhile, in Asia, the party days may
have come to an abrupt halt but the tone is of cautious optimism, not depression. The
‘decoupling’ thesis remains alive and well - the notion that China and India have built
sufficient economic scale, domestic consumption, and intra-regional trade within Asia to be
relatively immune from severe US weakening, leading their economies to cool but not
collapse. The ‘decoupling’ fans point out that US exports account for only 21% of China’s
total exports, and 14% of Asean’s.
If only all this were all true. Sadly, I continue to believe that there is far worse to come. If it
were just the sub-prime crisis, then recovery could indeed be swift with sufficient monetary
easing, write-downs, and fresh capital injections into the banks. But other fundamental
problems in the US economy have been allowed to go unchecked for years. If sub-prime
proves to be the trigger for these ticking time bombs, I believe the US economy has the
9 April 2008
Economic Outlook Q2, 2008 Page 5
makings of a ‘perfect storm’ ahead, and faces a recession deeper and longer than expected.
Asian decoupling will prove to be limited, and the world economy will also slip to
recessionary growth levels of around 2%. What makes it different this time are five
problems for the US that are independent, but when combined form a lethal cocktail.
Banking crises are different
This is not a normal cyclical recession. Banks are intermediaries in the monetary flow
between savers and borrowers - a vital organ the equivalent of the heart. If it stops,
everything stops, and it is not easy to get it started again. Bank crises are crises of liquidity,
not of a reduction in profits and returns on capital. They lead to a severe, and prolonged,
withdrawal of credit, which in turns leads to a dramatic restriction in business investment,
consumer spending, and widespread de-leveraging on both sides. Risk is avoided and
capital is preserved and used to pay back debt and rebuild balance sheets. This is
devastating for an economy, as Asians recall from their experience of the Asian Financial
Crisis. The Fed cannot force the banks to extend fresh loans to borrowers, however much
liquidity they provide them at low rates. Bankers move from ‘irrational exuberance’ in a
credit bubble (i.e. stupid lending in large amounts), to a state of shock when it bursts and
equally irrational credit restriction to even the best borrowers. As a result, there is always
contagion as otherwise good borrowers in other portfolios get infected: business loans,
credit cards, and prime consumer debt. The US will be no exception to this.
9 April 2008
Economic Outlook Q2, 2008 Page 6
A depression in the housing market is different
US new home starts and sales are at their lowest levels in sixteen years, and home prices are
falling for the first time since records began. The housing market strikes at the heart of the
otherwise resilient consumer economy that kept the US going through previous recessions.
The home is the primary asset for most households; its value drives perceptions of wealth
and propensity to spend. Feeling good about continuous home price rises is one thing, but
US consumers have been withdrawing that equity through home loans and spending it. The
shock effect of discovering house prices can fall will have a major impact on consumer
confidence. Rising house prices have supported about 20-25% of the US economy – think
not just construction, home sales building materials and estate agents, but also furniture,
carpets, DIY, and lighting. Much is at risk that has not been factored in as yet. And a lot of
those home décor items are sourced from factories in Asia.
0
50
100
150
200
250
Ma
y-6
3M
ay-6
4M
ay-6
5M
ay-6
6M
ay-6
7M
ay-6
8M
ay-6
9M
ay-7
0M
ay-7
1M
ay-7
2M
ay-7
3M
ay-7
4M
ay-7
5M
ay-7
6M
ay-7
7M
ay-7
8M
ay-7
9M
ay-8
0M
ay-8
1M
ay-8
2M
ay-8
3M
ay-8
4M
ay-8
5M
ay-8
6M
ay-8
7M
ay-8
8M
ay-8
9M
ay-9
0M
ay-9
1M
ay-9
2M
ay-9
3M
ay-9
4M
ay-9
5M
ay-9
6M
ay-9
7M
ay-9
8M
ay-9
9M
ay-0
0M
ay-0
1M
ay-0
2M
ay-0
3M
ay-0
4M
ay-0
5M
ay-0
6M
ay-0
7
Un
ad
juste
d M
on
thly
Nu
mb
er
of
Ho
usin
g U
nit
s
(in
th
ou
san
ds)
Housing Starts
75K
Source: U.S . Census Bureau, Bloomberg
Building Permits
73K
New Home Sales
43K
Median
home
price:
-8.2%
Feb ‘08
4
decade
record
U.S. housing market
9 April 2008
Economic Outlook Q2, 2008 Page 7
A good portion of recent US consumer growth has been artificial, and risky
The use of house capital as an ATM machine, combined with relentless borrowing on credit
cards and auto loans, has been building at a faster rate than earnings for over ten years. It
now stands at 13.6 trillion, or over 130% of total US household income. That means that a
good portion of the fabled US consumer’s ability to keep shopping has actually been debt
not matched by earnings-about 0.3-0.4% of annual GDP growth. For years, commentators
have warned of the risks this posed if the spell broke and the emperor was found to have no
clothes. Sub-prime is the straw to break the camel’s back, and the process of deleveraging
has started. Small business loans, credit cards and prime mortgages will be the first to feel
the chill, auto loans and others will follow.
80
90
100
110
120
130
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
USD 13.6Tn
% o
f D
isp
os
ab
le In
co
me
U.S. Household Debt
1,500
2,000
2,500
3,000
3,500
4,000
4,500
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
USD 4.1Tn
U.S. Government DebtUSD Tr
Source: U.S. FED & Treasury
The house of straw
9 April 2008
Economic Outlook Q2, 2008 Page 8
The world has an inflation problem that is secular, not cyclical
Much is made of the speculative contribution to the rapid inflation problem across all
commodity classes in oil, metals and foodstuffs. Speculators are contributing to price rises,
but this remains a demand side driven, long term adjustment of prices upwards. You cannot
suddenly add 2.5 billion people to the world’s free trading economy that were previously
locked inside closed socialist systems and not expect a major adjustment in demand and
prices. This is what has happened with the entry of China and India. Irrespective of short
term volatility in prices, over the long run Jim Rogers is correct. Even a food staple as
innocuous as rice is rising in price at a rate not seen since the last world war. The addition
of a major inflation dimension to slowing growth creates the ‘perfect storm’ scenario of
‘stagflation’. The worst job in the world at present, other than being a Wall Street CDO
salesman, is to be a central banker in Asia. Asia has a major consumer inflation problem and
should be tightening, just as the major monetary force in the world, the US, is loosening.
America’s cure is Asia’s illness.
9
Source: The Times UK
9 April 2008
Economic Outlook Q2, 2008 Page 9
US dollar depreciation creates as many problems as it solves
A decline in the status and value of the world’s fiat currency is a difficult transition. It is
partly to blame for the inflation problem - as the dollar depreciates, OPEC’s hand in
maintaining high oil prices has been strengthened. Much as the long term decline and fall of
sterling in the early part of the century was not always graceful, so goes the dollar. As then,
gold has stepped back in as the best store of value. However, the problem remains: how to
reduce exposure to the greenback and risk gracefully. Many currencies remain linked to the
US dollar, enormous dollar reserves have been accumulated by exporting countries, and
most commodities are still priced in dollars. Smaller investment groups such as ourselves
are lucky enough to have the freedom to vote with our feet, so that years ago we could
simply abandon the dollar. Others are not so lucky. Central banks all over the world, but
particularly in Asia, quietly wish to hold more Euro or even Yen, but have to appear
supportive to avoid pushing the greenback over the cliff. GCC countries, awash with
petrodollars, wish that oil was priced in something else. This reluctance to face the
inevitable does not mean that the dollar will continue to live another nine lives, but simply
that death will be replaced by decay. Already smaller systems historically long tied to a de-
facto dollar peg, Kuwait and more ominously Vietnam, have started the process of de-
linking. Asia is very slowly channeling reserves towards other currencies, as the GCC mull a
regional trade-weighted currency basket much like Singapore’s dollar. So whilst
depreciation should help reduce the US deficit and drive up US exports, the damage to the
rest of the world remains high.
0.9
1.1
1.3
1.5
1.7
1.9
2.1
80
90
100
110
120
130
140
150
Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08
YEN
SGD
AUD
CAD
but not the dollar
USD Against:
Source: Oanda
Sep-03
USD warning
(BCC/EB)
Feb-02
US debt level warning
(BCC/EB)
9 April 2008
Economic Outlook Q2, 2008 Page 10
Asia has not yet decoupled enough
Decoupling?
-8
-6
-4
-2
0
2
4
6
8
10
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008F
6.9%
6.5%
1.6%
1.5% 1.5%
Developing Countries
An
nu
al
% C
han
ge
Source: ECB; ASEAN; EIU; IMF
Annual GDP Growth
A common refrain is that Asia has ‘decoupled’ from the US economy. This is nonsense.
Firstly, decoupling is a journey, not a destination. With global free trade, Asia can no more
completely decouple from the US than the US from Asia, nor should it. Asia can, and is,
moving towards lower dependence on US exports and greater domestic consumption; with
over 3 billion people and a growing middle class they should be. But this journey will take
time; it is the law of large numbers. US consumption is over 9.6 trillion dollars. If this
declined 5% in a recession, the global economy would lose almost 500 billion dollars. This is
equivalent to a third of the entire consumption of all of China’s and India’s consumers put
together or the entire economies of Indonesia and Singapore. As for the reduction in export
dependency, the G3 countries continue to consume two thirds of Asian exports. Yes, Asian
intra-regional trade has grown fast, but most of it is semi-completed goods eventually
bound for the G3.
9 April 2008
Economic Outlook Q2, 2008 Page 11
Decoupling part 2
Source: ADB 2007, Factiva
East and
Southeast Asia
31.1%
Production
22.6%
East and Southeast
Asia’s Export
100%
Rest of the world
68.9%
Production
36.5%
Final
Demand
32.4%
To
tal F
inal
Dem
an
d
21.1
%
To
tal F
ina
l Dem
an
d
78
.8%
Others
17.5%
G3
(U.S.,
Eurozone, and
Japan)
61.3%
Final Demand
85%
Given this bad news, some have asked what has happened to my strong belief in the
emergence of Asia as expressed in previous writings. Actually, nothing. The long term
growth and secular changes in Asian economies, Asean as ‘Cinderella’, the remaking of
Singapore as ‘Monaco in the Tropics’… none of this has changed. This remains the story of
the decade and beyond, and long term investors should stay the course, as we do.
Depressing as my view on the US economy sounds, the pain over the next two years will
only advantage Asia. I believe we are witnessing the ’tipping point’ for the world economic
order: the peak of US economic and dollar dominance that has defined the 20th century,
much as British economic dominance and sterling defined the 19th. The world will re-align
to a new system more volatile politically, but better balanced economically. You can take
your pick which one you prefer, but the change is inevitable and has just been accelerated.
A shrunken US will be balanced by a more prominent Euro-zone and Euro; by the rising
powers of China and India; and by a struggling, but still relevant, Japan; and the toughest
part of this transition will be the slow change in status and value of the USD. This is not to
say that the US is about to keel over. This is not the decline and fall of the Roman Empire,
and the rest of the world has some way to go to match the dynamism of the 14 trillion dollar
US economy. But, very quietly in March this year, the 320 million people of the Euro zone
overtook the 300 million plus people of the US to become the world’s largest economy.
Late last year ICBC, a Chinese bank, overtook Citigroup as the world’s largest bank, a
dubious honour Citi has held for a decade. The times they are a ’changin’.
9 April 2008
Economic Outlook Q2, 2008 Page 12
Global Disclaimer This research note and/or opinion paper, article, or analysis has been released by Calamander Capital (Singapore) Pte Ltd., or its parent company or affiliates, to professional investors, clients, and business members of the British Chamber of Commerce for information only, and its accuracy/completeness is not guaranteed. All opinions may change without notice. The opinions expressed, unless stated otherwise, are not investment recommendations, or an offer or solicitation to buy/sell any funds, investments or other services of the Calamander Group, Calamander Capital, or its affiliates. Calamander Capital does not accept any liability arising from the use of this communication. Copyright © 2008 Calamander Capital. All rights reserved. Intended for recipient only and not for further distribution without the consent of Calamander Capital Pte. Ltd. For further details, please contact [email protected]. calamander capital (singapore) pte ltd (co. reg. no. 200723396M) MAS exempted fund manager 85 a/b circular road, singapore 049437 tel. +65 6723 8129 fax. +65 6491 1227
9 April 2008
Economic Outlook Q2, 2008 Page 13
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9 April 2008
Economic Outlook Q2, 2008 Page 14
