Expect Low Real Returns in Decades to Come

The S&P 500 Stock Index set a closing record of above 1900 points on May 23, 2014 . With that, we are likely to end the month on a high note for global equities. These large moves in global equity markets have been rather astonishing given it was less than 6 years ago we had the Global Financial Crisis of the 21st Century.

Being a fan of economic history and a believer of economic and market cycles, I appreciate what happened in the past may not necessary be repeated in the future. That goes without saying with regards to investment returns. In the past 30 years, starting from early periods of the 1980s, all major asset classes provided a fairly good real returns (nominal returns minus inflation). A well diversified portfolio of equities, government bonds, corporate bonds and alternative investments would have generated an annualized return of 10%. Taking into an account an average inflation of 4% during this period, the real return of a diversified buy and hold portfolio would be around 6%.

However, if one were to expect the similar returns for the next 30 years, the person would likely to disappointed as we are starting the next 30 years with high valuation of global equities (except China) and government bonds (less so corporate bonds). Based on the general assumptions of economic growth for the next 3 decades and current valuation of global invest-able assets, I would expect nominal returns to be in the region of 5% with an inflation rate of around 2.5%. This will reduce the real return from 6% in the past 30 years to 2.5% for the next 30 years.

Given the total return pie I have highlighted above is unlikely to adjust unless we have a significant shift in technological advancement or global demographics, anyone that wishes to generate outsize return on investments will be doing it through selection of strategies, timing of buying/selling of various asset classes and selection good fund managers. With that, it will mean even less real return for the remaining public.

My advice, for the next 3 decades, besides focusing on how to generates our income, one should also pay a lot of attention on where and how these incomes are invested.

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China H Shares Valuation Compelling In The Long Term

The recent talks of the high valuation of global developed countries’ equities and fixed income markets has unnerved some long term investors looking for compelling investment returns in the next 5 to 10 years. A nominal return of 5% for developed market equities or 3% for equivalent fixed income investments does not seems attractive by all means. If you tag on a 2 to 3% expected inflation, you are looking at barely any real returns in the medium to long term.

One market that stands out for global investors at the moment is Chinese equities and fixed income markets. Looking at the current valuations of Chinese Equities and Fixed Income it does look extremely attractive versus global developed markets in the long term.

China H Share

Current PE : 7.14
2014 Forecast Dividend Yield : 4.66%
Current Price/Book : 1.10
10 years Government Yield : 4.17%

S&P 500

Current PE : 17.21
2014 Forecast Dividend Yield : 2.08%
Current Price/Book : 2.61
10 years Government Yield : 2.49%

Euro Stoxx 50

Current PE : 21.13
2014 Forecast Dividend Yield : 3.58%
Current Price/Book : 1.52
10 years Government Yield (BUND) : 1.31%

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Citic Pacific Acquisition of Parent’s Asset – Unprecedented Breakthrough

Citic Pacific Announced that it would acquire all of the parents asset in an announcement on 26 March 2014. The asset is estimated to be worth over RMB220billion (US$38billion). This will include all of Citic Group businesses and assets in China not currently owned by its Hong Kong subsidiary. This move is extremely significant for China despite not having the same media attention.  Compare the number of articles and news in the market place this morning versus to the news of Chaori default recently,  it seems journalist and reporters put little value on this piece of news.

In my opinion, this is second major move in China’s effort towards SOE reform after Sinopec announcement on listing of its retail distribution business but a more significant one. The fact that all of the Citic Group asset will acquired and essentially owned by a listed company overseas governed by international market practices and law signal the REAL desire of China’s leader to reform its current economy towards a more market driven economy.

I can’t help but to feel very bullish on this new China and its profound effects globally. Having said that, in any inflection points in an economy there are bound to be volatility but the murky road of China will get brighter in the future.

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China Is Headed For Its First Domestic Bond Default – Is It Good or Bad For Investors? Remember GITIC?

For those who remember, 16 years ago in 1998 (2 years after I started my working life) GITIC, a provincial investment vehicle in China defaulted on its dollar bonds that had caused foreign banks and investors to panic. At that time, it was labelled as the first foreign bond default by a provisional government in China since Chinese Revolution in 1949. Why did the government allow GITIC to default and what was the consequences of it? The Chinese government allowed GITIC to default as a signalling to investors that they should be held accountable for their reckless lending. The consequences were future investors were being more selective in their lending and reassess the lending risk on Chinese companies.

Fast forward 16 years, the market potentially will see the first domestic bond default through Chaori Solar and potentially many more in weeks and months to come. This is much needed and timely to promote better lending and investment habits in China going forward. China is an economy with huge domestic net savings despite the strong credit growth in recent years. Hopefully through this lesson, efficient allocation of capital to those that need, deserve and more importantly value-add to the economy will help the government to maintain appropriate monetary condition to support the economic engine.

I have a strong feeling that domestic investors, both institutions and individuals will start to be more selective in their lending and investments. Inefficient and sub-par credit policies will see further improvement. Credit spreads of companies will start to reflect fundamentals of the borrowers rather than purely on implied ownership and importance to the economy. Should we worry about Chaori Solar default? I am not. I just hope there will be more to come and the Chinese government will allow more default to show to its citizens and corporations the meaning of risk versus reward. Only by allowing it will China risk premium finally narrow with western developed countries.

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Poll Results Of How Much Will Chinese Yuan Appreciate Against USD in 2014?

The Poll Result is out


How Much Will Chinese Yuan Appreciate Against USD in 2014?.

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How Much Will Chinese Yuan Appreciate Against USD in 2014?

How Much Will Chinese Yuan Appreciate Against USD in 2014?

I created a similar poll in December 2012 on LinkedIn. The result of the poll accurately predicted the movement of Chinese Yuan against USD. I hope more people will participate in this poll which will end on January 31, 2013

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Japanese economy and US Treasuries

Sitting on the plane in Haneda Airport in Tokyo can’t help to feel a sense of relief that two of my main macro predictions of 2013 were met this morning. 10years UST reached 3% yield while USD JPY crossed 105.

The former is the result of the potential FED QE pull back and bullish outlook on the US economy while the later is a catalyst for further bullishness in the Japanese economy in years to come.

Equity valuation in the US is at recent historical high caused by money moving out of bond into equity funds. However history has shown that the current pace of rising valuation is unsustainable. Bears on US govt bonds should beware if they are behind the curve as we could see an adjustments in equity markets in 2014 and the bond market will once again be the shelter if the 10years UST yields reaches 3.5%.

In the case of Japan, with a 30 percent fall in the currency, I am witnessing a very cheap Japan. Not from the perspective of the equity market but from the perspective of the real economy with real goods and services. My wife and I noticed that products ranging from cosmetics, basic consumer products, supermarket foods to higher end services like ski rentals to coaches are significantly cheaper that major cities in Asia. Hence unless there is a corresponding rise in inflation and bond yields the current yen at USD JPY rate of 105.00 would be a good level to square all yen shorts.

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