"Kee" Points with Jim Kee, Ph.D.

Time for a quick trip around the world before year’s end!


U.S. and the fiscal cliff: “A game of chicken always ends at the last minute.” -That’s how the  Financial Times describes the fiscal cliff situation in the U.S., and that's why markets are so calm about it. It is certainly crunch time with respect to getting a deal done this year, and House Speaker John Boehner’s offer to allow tax rate hikes is considered to be the needed prerequisite step. But this is the crucial week. Models I have seen show anywhere from 7 to 20 percent upside in the market (S&P 500) even if tax rates increase somewhat, primarily because (1) the market never priced the tax cuts to be permanent, and (2) risk levels (the “equity risk premium”) are elevated and should start coming down toward longer-term averages once a fiscal resolution is forthcoming. On the other hand, a full reversal of the 2003 tax cuts with the equity risk premium remaining elevated (the worst case scenario) would result in 20 percent downside (Credit Suisse). But that’s largely seen as the most unlikely scenario.


Europe: European Union “break-up panic” reached its peak last year and has declined greatly since. Hong Kong-based GaveKal, an investment research firm, attributes this to three factors, (1) the gradual moving forward of the pan-European banking union that was announced at the June summit; (2) the announcement of outright monetary transactions (OMT) in which the European Central Bank can purchase unlimited sovereign bonds for countries in need; and (3) the latest Greek deal, in which Germans have agreed to take losses on Greek debt (through a lengthening of the duration of loans extended to Greece, an interest holiday of 10 years, and a debt buyback program completed this week).


China: Premier Wen Jiabao was replaced by Li Kequiang, and the new Communist party chief is Xi Jinping. I don’t know if I’ll ever mention those names again, but according to (again) Gavekal, which admits that official memoranda on the transfer of power are hard to interpret (“a peculiar dialect spoken only by bureaucrats in Beijing”), the official goal for 2013 is “sustained and healthy” economic growth rather than the goal of “stable and relatively fast” growth of the past few years. Official growth targets are the 7 percent rage rather than the 8 percent range, although historically, actual growth rates have far exceeded the official targets.


Japan: General elections in Japan are now being held, and former Prime Minister Shinzo Abe, who stepped down as Prime Minister in 2007, is expected to be elected again. That makes seven Prime Ministers in six years – a lot of political “churning” for private sector companies and markets to deal with. Abe is running on the promise of more public sector spending and monetary easing, and I know of few economists who are optimistic about that. Kee Points readers probably know that I agree with the late Nobel Laureate Merton Miller that Japan’s problems lie with the capital allocation process in Japan.  As such, they will only be resolved through a privatization of the Japan Post and a more competitive market for corporate control (takeovers, LBO's, management buyouts, etc.). I see little change happening from government spending or monetary policy tweaking in Japan.


Emerging Markets: No economist is really happy with that classification of countries that mixes together commodity-based economies, manufacturing intensive economies, petroleum intensive economies, and countries that are pretty much developed. Nevertheless, most emerging market indices have lagged the developed market indices over the past 12 months, but they have started to close the gap in the last month. This seems to me to be consistent with declining global risk, and I think it explains why emerging market indices have been mirroring European stock market indices over the past several years.