Pragmatic U.S. and China versus chaotic Europe

Two-hundred high-level U.S. officials are in Beijing, meeting with their counterparts to discuss a wide-ranging issues from currency to human rights. A sense of pragmatism seems to prevail over anger and finger-pointing.

Both countries have produced bold monetary and fiscal policy responses to comeback the global financial crisis that started in the U.S. As the result of their actions, the economies in the U.S. and China are recovering and providing the support for the global recovery.

More pragmatic, coordinated or joint actions will be needed, to deal with issues that arise from bilateral and multilateral trades. The economic interests of these two leading countries are too-intertwined and too influential to leave them under the emotional influence of sometimes over-blown protectionism.

In contrast, Europe seems to be in chaos. The ECB is consistently behind the curve in dealing with macro crises. This article from the Big Picture has a good summary of the main problems that need to be tackled by European leaders.

Greece's sovereign debt problem must be dealt with as what it is: The country is insolvent; both the Greek and the banks who have lended to them must live with the consequence. Debt restructuring should be done sooner rather than later.

Germany as a big exporter, is benefiting from the depreciation of Euro. As the leader of EU, it should act to provide stimulus to the regional economies.

The lessons from the U.S. and China is clearly that the central bank must act bolding to promote market confidence in the financial system. The fate of the Euro and the ECB are tied up with its member countries. Independence does not mean inaction.

We hope that pragmatism will also prevail in Europe.

When the market is so fearful, get greedy

It is Warren Buffett who stated that “Be fearful when others are greedy and greedy when others are fearful”.

Market has turned very fearful, with the VIX shot up into the 40s over the last weeks. It's all coming from the fear that the Greece crisis may turn into a global credit crisis, Lehman Style. Hedge funds are unwinding the pro-growth trade, a bet on growth oriented countries and companies, with the belief that the concerted efforts of central banks and governements are sufficient to turn things around.

The European sovereign crisis calls the thesis into question. Many have concluded that the economic growth is not going to be very robust. The New Normal thesis is back.

Flight to quality has driven up US long bonds, making it one of the best performing asset classes year-to-date.

The pullback this time is over 10%, more severe than the early February pullback. Yet, other than the European problem, the U.S. recovery is now on a firmer footing.

Perhaps it's time to get greedy.

Wells Fargo has become the largest U.S. bank

Less than four months after my earlier post about Wells Fargo becoming the largest capitalized U.S. bank, it has now overtaken JP Morgan and Bank of America in market cap. At $33.5/share, Wells is valued at about $175B, while BofA is at $172B, and JP Morgan which used to be the largest is now at about $164B.

This change of positions are largely due to the potential impacts from the pending financial regulations which aim squarely at Wall Street and trading operations. Among the large banks, Wells Fargo has the least exposure.

In addition, the recent European sovereign turmoil, and the worry about writedowns that many of these European banks and international banks may suffer from, have added to the change. Wells Fargo is more of a pure U.S. commercial banking play, whereas B of A and JP Morgan, Citigroup all have sizeable international franchises.

It is also interesting to observe that HSBC which has more concentration in Europe and Asia, has seen its market cap drop to about $172B, behind Wells as well.

It pays to be more focused on earnings quality and being truely conservative.

The widening criminal investigation on Wall Street firms from Morgan Stanley, to Citigroup, to JP Morgan in particular may do a lot of damage to trading firm's reputation. Interestingly, Goldman Sachs, being the first to be investigated now may start to gain back its composure because everyone on Wall Street is in the same boat. When Goldman's clients look at this picture, what are they going to conclude? You still go with the "best."

Jobs jobs jobs

Non-farm payrolls increased by 290,000 in April, much more than the 180,000 expected by economists. March figure was revised from 162,000 to 230,000. Even after subtracting the temporary census jobs added in April, the economy has started to add substantial amount of jobs (about 224,000), mostly from the private sector. This is not surprising anymore given the robust earnings reports from retailers to hotels to car makers.

The recovery is no longer jobless. NBER should be comfortable to declare that the Great Recession was over.

Unemployment rate will remain high near 9-10% for some time as more workers now become active in searching for jobs.

We expect the jobs numbers to accelerate in the coming months. We need 300,000 or more per month for the rest of the year.

The news did little to help the market which appears to continue to be absorbed by the fear of Greek contagion. It's a real opportunity.

How panicky it was today!

As all major indices dropping straight down today, I felt like the episode of August 2007 had returned. That was when the two Bear Stearns mortgage funds were shuttng down, and most quant equity strategies were losing money big time. It was the harbinger of what was to come in 2008.

Could today's event be something similar? Or the market just got short-circuited due to the fear of European contagion?

The selling was across the board. Everything, including stocks that are unrelated to international trade or finance, went down rapidly, before recovering some.

Dow at one point was down nearly 1000 point. Some of the stocks I was watching were down more than 20%. Truely amazing.

I have been reading up on European Union and Euro. I'm inclined to think that the sovereign debt problem is nowhere near the mortgage debt problem we've had. Greece will be dealt with or will linger on and shrink. Portugal and Spain will be dealt with or will linger on and shrink. Euro may continue to drop or even collapse. It will be a source of great volatility. But then so what? It was just a monetary experiment, an idea or a strategy to counter the dominance of the U.S. and the rise of Asia. ECB is not an effective central bank. If the problems it now face will bring it down, so be it. The nations in EU would then have the freedom to choose their own destinies.

The real economies will continue. Businesses that can take advantage of the weak Euro are going to thrive.

So why the panic given the small size of all PIIGS economies? They're neither a critical source of energy or raw material nor a major consumer market. They're not going to derail  the global economic recovery led by US and China.

I actually bought some shares during the few minutes of big drop.

Gold price, reflecting the great uncertainty over Euro, has gone over $1200/oz. This is precisely the reason to hold gold. Yet, some of the precious metal funds have been disappointing. For example, Vanguard's VGPMX has not only under-performed some of its peer funds, but have under-performed both GLD and GDX. Now we know for the hedge using gold to play well, we should get the real gold, or gold futures.

We've been right about raising cash, limiting exposure to banks and increasing short. But, rotating more into industrial, material and energy now appears a bit pre-mature.