The macro traders who think they can provoke Beijing into a major one-off devaluation aren’t likely to get one, in my view. To paraphrase Keynes, Beijing can stay stubborn longer than traders can stay solvent.
The Other Side Of The Coin
As I noted above in reference to Donald Trump, FX rates have two sides. If one side goes up, the other must go down. If you believe the yuan will weaken, you also believe the dollar will strengthen, which in fact it has done in recent years.
Bearish yuan sentiment is also bullish dollar sentiment. A month or so ago, when the Federal Reserve told us it foresaw four interest-rate hikes in 2016, many thought this trajectory would be positive for the greenback. They might have been right, too, but now it appears unlikely that we will ever find out. No one expects a Fed move next week, and the odds are getting slimmer that we will see any more rate hikes through the end of 2016. Maybe just another token move this summer? And maybe the data trends can turn around – that is something we all would like to see. But the markets are not expecting more than one or maybe two interest-rate bumps this year.
So something curious has happened. People turned bearish on the yuan because they were bullish on the dollar. Now the prime factor behind the expected dollar strength has changed, but the bearish yuan sentiment is still with us. And dear gods, what will happen when the world goes into another recession and the Federal Reserve starts another round of easing? That scenario would be dollar bearish. Will US politicians stand up and accuse the Federal Reserve of participating in a currency war? Just asking.
Is there some new, different reason to think the RMB is headed down? Maybe. The faulty circuit-breaker scheme behind this month’s Shanghai stock selloff didn’t inspire confidence in Beijing. Whatever Chinese citizens think, it sure looked like a bone-headed move from the outside.
Yet remember what happened. When Shanghai couldn’t stay open for even an hour without tripping the breaker, the powers that be recognized their mistake and backtracked quickly. By their standards, that response was equivalent to jumping into hyperspace. Chinese authorities rarely move so fast.
You can call their reaction panic if you want, but it also shows something else: flexibility. A supposedly hidebound, dogmatic regime turned on a dime when it had to. Would the same have happened in the US? I don’t think so. We would have watched markets crash, convened a blue-ribbon panel to investigate, and then made some tweaks a year or three later.
Admitting mistakes is hard, even for communist governments. That Beijing can do it when necessary suggests that they will not be easily bullied.
I began this issue by comparing Chinese markets to the Monkees. If you never saw their 1960s TV show, it was a shameless attempt to exploit Beatlemania. As a band, the Monkees were strictly made-for-TV.
Yet something unexpected happened. The four young actors turned themselves into musicians. Some of their music was forgettable, but some of it was pretty good, too.
China’s attempts to build modern markets and join the international financial elite can be funny to watch – but won’t always be so. Like the Monkees, China has a chance to actually become what it once only pretended to be.
The Chinese are in the middle of that process right now. Beijing has many Daydream Believers. Bet against them at your peril.
Hollywood (Florida), Cayman Islands, And Surprises
I fly tomorrow to Hollywood, Florida, where I will participate in the ETF.com conference with some 2000 people, talking about all things ETF. I will be giving the keynote address at the Tuesday lunch, doing interviews, holding meetings, and of course doing the rounds of dinners and gatherings every evening. I expect to learn a lot. If things work out, I will get to spend some time with old friends Dennis Gartman, Mark Faber, Steve Blumenthal, Jeff Gundlach, Jason Hsu and Mark Yusko, plus join in tons of meetings and dinners and make new friends. It will be a very busy three days.
The following week I fly to the Cayman Islands to speak at the Cayman Alternative Investment Summit, one of the biggest hedge fund and alternative investment gatherings outside of the US. They have an impressive lineup of speakers, and I note that this year the celebrity guest speaker is Jay Leno. That should be fun. I just looked through the speaker list and noticed that Pippa Malmgren, who will also be at my SIC conference, is speaking, and it will be fun to catch up with her again. I will be on a panel (moderated by KPMG chief economist Constance Hunter) with old and brilliant friends Nouriel Roubini and Raoul Pal. At least I know that with those two guys there is no need to wear a tie.
It was interesting to go back and listen to the Monkees while I was writing this letter. They were a part of my youth, and they got a lot of radio time. Who can forget “Last Train to Clarksville,” “Daydream Believer,” “I’m a Believer,” “Pleasant Valley Sunday,” or “Stepping Stone?” In doing the odd bit of research here and there, I found out that at their peak in 1967, they outsold the Beatles and Rolling Stone combined – though after their string of hits they fell off the charts faster than subprime mortgages. Leader Davey Jones passed away in 2012, but the remaining three still put together reunion tours every so often, and if they ever get near me again I might just go. They also cranked out their share of forgettable songs, but you nostalgia buffs can groove on their greatest hits here.
Since it’s just us friends talking, I will admit to actually buying a stock a few days ago. It’s a huge regulatory issue for me to mention what stocks I’m buying in this letter, so I won’t. But this was a company and an industry (not energy) I am familiar with and have been following for a while, and their stock has been dropping like a stone. When their physical dividend got to 27%, I called my broker and a few analysts and asked what gives. I heard all sorts of reasons as to why the stock might be going down, but when I look at their free cash flow, which is now about 75% of their total market cap, it looks to me as if they have plenty of coverage on their dividend. This is a company that is not going away. But at the price I bought, even if they cut their dividend in half, which I don’t think is likely to happen, I would still get a 13% yield, which in my considerable experience is pretty juicy.
When I get on the phone with friends, they are talking about all sorts of MLPs with yields in the teens, some of which I wouldn’t touch with a ten-foot pole and others of which I have to admit are quite tempting. Yields that high can cover a lot of sideways movement in the market for a long time. Companies that analysts don’t seem to understand and that are in unloved industries – but still have a dominant business model and a management team that is solid – are starting to show up on my radar screen. I tend not to buy individual stocks but prefer to buy managers. Just a personal preference. But every now and then I make an exception, generally when I see something of compelling value. Right now it looks as though I randomly picked the absolute bottom for the company I bought, but who knows? In another month that yield might be 30% as another slide comes along. Or there could be a dividend cut. But frankly, where I bought it, as long as they ke ep paying me that dividend, I really don’t care.
If the stock works out, I’ll look back and wonder why I didn’t put 10% of my portfolio in it. I am very light on fixed-income and yield plays – I’m actually very happy about that, as there are too many opportunities that give me more potential than the typical fixed-income 3–4% returns – but I could use more of them. If the stock doesn’t pan out, then you’ll hear me say it wasn’t that big a deal. I’m just as human as anyone else. I’ll let you know in a few years whether I was an idiot for not buying more or whether I was an idiot for buying at all.
Follow John Mauldin as he uncovers the truth behind, and beyond, the financial headlines in his free publication, Thoughts from the Frontline. The publication explores developments overlooked by mainstream news and analyzes challenges and opportunities on the horizon.