Update No. 28 – 09/10/11

The market staged a big turnaround this week; unfortunately our holdings didn’t keep pace.  I guess the question is – can the gains be sustained.  It is hard to tell, but to my way of thinking, positive economic news is starting to out-weigh negative economic news.  I always focus on US news, because like it or not, the US is still the worlds economic engine.  August US building permits were up 3.2% month on month and 7.8% year on year, September is expected to be marginally better still.  Building permits are an approximate 6 to 12-month leading indicator to housing starts, which is a pretty direct proxy for the strength of the building industry, which is in turn consistently underestimated as a key driver for growth and employment.  Total housing starts for the whole of calendar 2009/2010/2011 will be less than they were in each of the 2002/3/4/5 calendar years.  In fact fewer US houses have been built in the last 3 years than the average constructed each year on average for the 10 years prior to that.  The excess supply has been largely absorbed, the only question is how long it takes the market to react to the new undersupply situation and more than double the current new home construction to return it to its equilibrium level of about 1.3m per year.  I would be surprised if by the end of 2012, housing starts weren’t up to about 900k per year and unemployment below 7.5%.  These are not forecasts, just a supposition as to how a rational market would react (remembering the market is rarely perfectly rational).

Real GDP in the US increased to 1.3% in quarter 2 and is particularly impressive when you consider a relatively high inflation rate of 3.8% reported in August (real GDP measures the GDP factoring inflation).  Another big positive is a recent narrowing of the trade deficit, combined with the continued strong growth in exports (set the chart to 5 years to get a good feel for how impressive the growth is), this proves the enormous ongoing effort to weaken the US$ is working (like it or not).

The other side of the coin of course is the Euro-currency zone and Europe generally.  The Euro-Zone is an economic area comparable in GDP to the US.  Unfortunately, I am not so excited by Euro-Zone prospects.  I have always been sceptical of the workability of a common currency across a disparate group of economies.  Unless a country has the capacity to weaken its currency when its economy is weaker than the global average (either through natural forces, or by manmade force as the US has done), trade factors will be distorted and an economy has no means of finding equilibrium.

I can attest to what a wonderful ‘concept’ the Euro is, having spent time travelling through Europe, spending the same notes and coins in nearly every country.  Despite this, whatever improvements in trade and portability the Euro has created, the is enormous downside is being witnessed by the weaker Euro economies now.  Under normal conditions, Greece’s currency should have plummeted, they should now be in the midst of an export led recovery, probably led by tourism, but supplemented by other Greek export industries – fruit, vegetables, olive oil, textiles and steel.  The weak currency would make imports prohibitive and some sense of normality would quickly be established.  Foreign Greek bond-holders would be burned by currency losses rather than capital losses.  None of these normal solutions can occur because of the distortion caused by the shared currency.  The best thing the Euro-Zone could do is declare the Euro a failure and return to floating sovereign currencies in the most orderly way possible.  This option is enormously politically difficult, but will likely have to happen in the next few years to help Europe deal with its issues properly.

In any case, I don’t hold out much hope for the sparks of a recovery coming from the Euro-Zone, but I am very hopeful of a US led recovery – Tony Hansen 09/10/2011

P.S. talking of currencies, there are many more benefits than costs to the Chinese in allowing their currency to trade somewhere closer to fair value – also the global economy would benefit.

EGP Fund No. 1 Pty Ltd. Down by 6.9%, leading the benchmark by 1.27% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 0.92%, leading the benchmark by 12.78% all-time (April 1^st 2011).

EGP 20.  The EGP20 index is Down by 10.15%, lagging the benchmark by 2.02% since July 1^st.  Since inception the EGP20 is Down by 20.6%, lagging the benchmark by 8.74% all-time (since April 1^st 2011).

S&PASX200TR  The benchmark index is Down by 8.17% since July 1^st. The benchmark is Down 11.56% all-time (since April 1^st 2011).