China’s First Default and Export Collapse; Russia’s Financial Meltdown

China’s First Default and Export Crash

A few hours after the close of the Friday’s trading session in Asia, news announced of the first China onshore default on bonds[1]. While the manic US stock markets seem to have shrugged this off, it is unclear if Asian markets will also disregard this. 

Even worse, after the close of the trading hours in US, the Chinese government announced[2] of a steep 18.1% decline in exports!!! I would say that 18% EIGHTEEN PERCENT represents a collapse and not just an ignorable drop.

The export crash has brought about China’s trade balance into a massive deficit. Yet both the degree of export volume breakdown and the scale of deficits matches or has even been larger than during the global crisis of 2008 (see red ellipses). Whether this represents an anomaly or signs of the deepening and acceleration in the deterioration of China’s economy has yet to be established. But I suspect the latter.

Why?

Because as I have been pointing out, such is how the bubble cycle unfolds.

The first stage; financial market disruption. Then, liquidity squeeze. Lastly, either a financial crisis that brings about an economic crisis or vice versa. The Chinese markets had her financial market disruption episode in June 2013. Then the attendant spike in interest rates underscored on the liquidity squeeze which the Chinese central bank has been intensely firefighting with liquidity administration[3].

Now the real world contagion.

In 2014, we seem to be witnessing the combination of financial market disruption and real world economic problems, particularly, the first trust bailout[4] in late January, the unreported January quasi-‘bank run’ on three cooperatives which just surfaced last week[5], the reversal of the one way yuan trade[6] and now both the first default and export meltdown. In barely three months, accounts of financial-economic convulsion appear to be increasing in frequency and intensity.

Remember, Chinese ‘zombie’ non-financial companies with debt-to-equity ratio exceeding 200% have reportedly jumped from 57% to 256 from 163 in 2007 according to a report from Bloomberg[7]. This implies of the potential scale of the risks of defaults, not to mention the risks from $3 trillion of local government debt and China’s shadow banking industry estimated[8] between $7.5 trillion (JP Morgan) and $15 trillion (Fitch’s controversial Charlene Chu)

So aside from higher cost of funding which results to dislocations in economic operations and subsequently engenders an economic slowdown, a feedback loop of slowing economic growth magnifies on the debt problem by aggravating access to funding which translate to higher costs of financing.

This is why the first default has been analogized by some mainstream pundits as China’s ‘Bear Stearns moment’ as climbing rates and the risks of payment delinquency will pose as major roadblocks to interbank lending that increases default risks. 

And it is important to point out that in contrast to the external account talisman that the mainstream uses to justify their worship of bubbles, in China’s case surpluses dramatically morphed into deficits. In addition, China’s record forex reserves hardly serve as an adequate shield to a DEBT problem issue.

As I have projected at the start of the year, China’s unwieldy debt conditions may trigger a Global Black Swan event[9].

Evolving events have been indicative towards such direction.

Russian Financial Markets Meltdown

And this has not just been a China affair. Financial strains in emerging markets have been sporadically spreading. While ASEAN’s pressures may seem to have eased (I say temporarily), Russia suffered a financial market meltdown last week.

It would be misguided to treat or impute Russia’s problems to entirely the Ukraine standoff. As I pointed out earlier, in contrast to mainstream understanding which views the weakening Russian ruble as foreign money instigated[10], this has been mostly a resident capital flight phenomenon[11]. The falling ruble existed even prior to Russia’s troop build up in Crimea.

The intervention by the Russian government has only aggravated such conditions. And in trying to preempt the outflows from a deepening corrosion of sentiment, Russia’s central bank Bank Rossii hiked interest rates by 150 basis points. The result has been a horrific (12%) one day crash in stock market, bond markets and even the ruble[12]. All the stock market gains accumulated from June of 2013 vanished in just one day. Russia’s stocks as measured by the MICEX closed the week down 7.29% which means about 40% of the losses have been recovered. Dead cat’s bounce, perhaps?

And all it takes is for political maelstrom to expose on the real issues: DEBT.

And again despite the huge forex reserves of both China and Russia, worsening credit conditions have overwhelmed or negated any so-called advantages.

And to put into perspective from the heavily biased reporting seen in most of mainstream media about the geopolitical impasse between the US and Russia, under the previous terms and agreement by Ukraine and Russia, Russian troops “has been allowed to keep up to 25,000 troops on the Crimean Peninsula”[13]. Now whether troops operating outside the bases are legitimate or not is subject to anyone’s interpretation.

But so does interpretative conundrum apply to the historical attachment of Crimea with Russia. Crimea had been a part of the Russian empire in 1783 way until the General Secretary of the Communist Party in Soviet Union ‘Ukrainian’ Nikita Khrushchev transferred in 1954 “the Crimean Oblast from the Russian Soviet Federative Socialist Republic to the Ukrainian Soviet Socialist Republic” notes the Wikipeida.org[14]. Ukraine became independent[15] from the Soviet Union following the latter’s dissolution in 1991.

So the Crimean political crisis is a complex issue being oversimplified by media.

I would like to also further note intervention has been a two party affair. Early February news leaked of the hacked phone conversation between US Assistant Secretary of State Victoria Nuland and US Ambassador to Ukraine Geoffrey Pyatt in actively plotting over the ouster of the previous Ukraine leadership[16] and of the prospective instalment of their candidates.

And Ms. Nuland also reportedly confirmed according to UK’s Guardian “that the US had invested in total "over $5 billion" to "ensure a secure and prosperous and democratic Ukraine" - she specifically congratulated the "Euromaidan" movement[17].”

So the pot calls the kettle black.

The Contagion Link

 

Going back to economics, in terms of trading linkage, ASEAN represents the fourth largest trading partner of China[18] (left window). The EU has been both the largest trading source for China and Russia. China is the second biggest trading partner of Russia[19] (right window). So a China and a Russian economic downturn imply that the biggest damage will be on the EU.

And that’s just the context of trade and doesn’t cover capital flows.

The implication of China’s export meltdown is that the global economy may have taken a sharp downturn in February. This will be reinforced by Russia and all other Emerging Markets (Turkey, Brazil, India, ASEAN and etc…) recently hit by the yield spread disorderly adjustments.

And as of December 2013, according to the Philippine National Statistics office, China has been the largest source of Philippine imports[20] and the second largest export market[21].

And as I previously mentioned US and European banks have intensely increased bank lending to emerging markets[22].

So should China and or Russia’s financial-economic turmoil escalate, the idea that the ASEAN or the Philippines will be immune from this will just seem utterly delusional. Or the fugazi.

---

[1] See China’s First Onshore Default! March 7, 2014

[2] Bloomberg.com China’s Feb. Exports Unexpectedly Decline in Blow to Confidence March 9, 2014

[3] See PBoC Injects 255 Yuan to Calm Debt Jitters, Asian Stock Market Celebrate January 22, 2014

[4] See China Rescues Troubled Trust Product January 28, 2014

[5] See China’s Bear Stearns Moment? First Bond Default Looms March 6, 2014

[6] See Has the Falling Yuan and Tumbling Chinese Stocks Been Signs of Capital Flight? March 3, 2014

[7] Bloomberg.com Zombies Spreading Shows Chaori Default Just Start: China Credit March 7, 2014

[8] See Global Markets: How Sustainable is the Recent Risk ON? February 17, 2014

[9] See Will China Trigger the Black Swan Event in 2014? January 20, 14

[10] See Behind Russia’s Central Bank’s “Unlimited Intervention” January 31, 2014

[11] See Emerging Market Turmoil: The Fallacy of Foreign Currency Reserves as Talisman February 3, 2013

[12] See EM Crisis Over? Explaining the Meltdown in Russian Financial Markets March 4, 2014

[13] Voice of America Russian Forces in Crimea: Who Are They, Where Did They Come From? March 5, 2014

[14] Wikipedia.org Crimea Early History, Independent Ukraine

[15] Wikipedia.org Ukraine independence

[16] Euronews.com US embarrassed by apparent hacked phone call dismissing EU on Ukraine February 7, 2014

[17] The Guardian Ukraine crisis is about Great Power oil, gas pipeline rivalry March 6, 2014

[18] Wikipedia.org List of the largest trading partners of China

[19] Wall Street Journal Lawmakers Pass Russia Trade Bill November 16, 2012

[20] Philippine National Statistics Office External Trade Performance: December 2013

[21] Philippine National Statistics Office Merchandise Export Performance : December 2013

[22] See Emerging Markets: Why Adjustments For Relative Yield Spreads has been Disorderly February 17, 2014

EM Crisis Over? Explaining the Meltdown in Russian Financial Markets

In contradiction to the consensus outlook whom sees that EM volatility as just an aberration, well three months into the year, from China to Thailand to Ukraine to Kazakhstan, yet we see another financial market seizure: This time it is on Russia. 

The Russian Central Bank, Bank Rossii declared a 150 basis point hike in interest rate last night, from Bloomberg:

Russia raised its main interest rate the most since 1998 as the currency plunged to a record and investors pulled money from the stock market on concern that President Vladimir Putin will invade Ukraine.

The one-week auction rate, the benchmark introduced in September, was increased temporarily to 7 percent from 5.5 percent, the Bank Rossii said on its website today. The regulator also temporarily raised its other major lending rates by 150 basis points, or 1.5 percentage points.

The response has been a ghastly havoc in Russia’s financial markets

The Russian equity index the MICEX collapsed by a staggering 10.79%!!! 

The MICEX meltdown represents another wonderful example of “volatility in both directions but with a downside bias”. Months of accrued gains only to vanish in one day.

Russian bonds were also crushed! Yields of 10 year Russian bonds soared by 54 points.

Adding insult to injury has been a rout in Russia’s ruble (vis-à-vis the US dollar). The Russia's central bank, the Bank Rossii has been reported to have sold $10 billion worth of US dollar and raised interest rates. The ruble sank by a record 1.8% last night, bringing back the specter of 1998 as noted by the article.

It’s easy to blame Russia’s military involvement in Ukraine’s political quagmire as possible proximate cause, but as a bank analyst rightly commented "But today's price moves are hardly related to Ukraine exposures. What's happening today is that people are factoring in higher country risks" for Russia”

But the most important issue is; why would a 150 basis point hike spur a stampede out of Russian assets?

Well the answer all boils down a four letter word which the consensus shun at: DEBT

Political and economic uncertainty from Russia’s intervention in Ukraine signifies only a secondary cause or an aggravating circumstance acting as the release valve for what has been a seething buildup of economic and financial imbalances. 

Russia’s predicament has become evident even as early as late January when the Bank of Rossii announced “unlimited intervention” in the face of EM convulsions and a suspension of deposits from a local bank MY Bank.

Then I asked “The question is will this serve as a temporary patch or will this enough to calm Russia’s financial tantrums?” 

Well yesterday’s actions seem to have provided an answer. 

I also noted that Russia’s dilemma—contra mainstream expectation—has centered on resident capital flight. The weakness of the ruble has been a resident, and barely, a foreign instigated dynamic. And the Ukraine political impasse will only compound on this. Because not only residents will see increasing uncertainty as a factor in influencing Russia’s credit quality conditions, foreigners will likely exacerbate on this. Thus the meltdown.

From the same Blooomberg article above:

Foreign reserves fell to a three-year low of $490 billion on Feb. 7, a week after Deputy Economy Minister Andrey Klepach said that capital outflows may reach $35 billion in the first quarter, more than half of the $63 billion that left Russia in all of last year. Reserves have since risen to $493 billion.

So by raising interest rates, the Bank Rossii hopes to stanch the outflows by preempting them. Weak ruble will mean higher rates, so Bank Rossii gave it to them in one shot.

The question now is the how will the hike in interest rates affect the highly indebted entities, including Russian local governments? Will defaults become an issue? Will defaults spread or will they be constained? How will the Russian government respond to such a scenario? Bailouts? Massive inflation?

Importantly, for those in the consensus who thinks that huge foreign reserves, surpluses in current account and balance of trade should function as a talisman against the debt demon, well it appears that in Russia's case such expectations have proven to be a myth. 

A Moscow Times headline noted that Russian banks can easily absorb credit losses in Ukraine: 

Moody's estimated in a December report that the exposure to Ukraine of four Russian banks — Gazprombank, Vneshekonombank, Sberbank and VTB — was about $20 billion to $30 billion.

Another Wall Street article downplays European Bank exposure on Russian debt

Ukraine's impact on western European banks will be more limited than it would have been in the past, as direct cross-border exposures are less than half their level in 2008, said Elena Romanova, an analyst with Raiffeisen International. Prior to the financial crisis, European banks were chasing market share in what they perceived to be one of the continent's last high-growth markets. However, those banks now hold less than 20% of Ukrainian bank assets.

But such optimistic perspective appears opposite to how the financial markets responded last night.

European banks, as measured by Euro Stoxx Banks, got crushed also last night down by a terrifying 3.84%.

Add to this Germany’s major bellwether the DAX was also hammered by 3.44%.

While the above may just be a knee jerk reaction, which I think is not, they serve as a lucid paradigm of the transmission mechanism from the periphery-to-the-core phenomenon.

The end of the EM crisis? Hardly. 

All these represent a process unfolding over time. First, financial market disruption. Next, liquidity squeeze. Then, either financial crisis that leads to economic crisis or vice versa.

All these increasing incidences of emerging market turmoil signifies just an appetizer to the forthcoming global Black Swan event.

Behind Russia’s Central Bank’s “Unlimited Intervention”

With the ruble under fire, the Russian central bank mimics ECB Mario Draghi’s “Do whatever it takes” with their own “unlimited intervention” in the hope to stem the faltering currency. 

[I’ll argue below that this seems more than about the currency where the latter is only a symptom]

From Bloomberg:

Bank Rossii, which aims to let the ruble trade freely by 2015, bought the most rubles since September 2011 this week to slow the currency’s drop as central banks from Turkey to South Africa raised interest rates to prop up their currencies. The Moscow-based regulator will intervene “without quantitative limitations” until the ruble returns to the target band or the corridor is lifted to its level, it said in a statement on its website, reiterating the present framework for the currency…

The central bank has spent $29 billion since May 29 to smooth exchange-rate fluctuations, cutting its gold and forex reserves to $496.7 billion, the lowest level since 2011.

The effect of Bank Rossii’s “unlimited intervention” has been to spike ruble against the USD yesterday. The ruble has been under pressure along with most emerging markets currencies. 

The question is will this serve as a temporary patch or will this enough to calm Russia’s financial tantrums? I believe that like her peer, the Turkish central bank's who surprised with a “shock and awe” of dramatically pushing up interest rates, this will have a short term impact.

And like everywhere else, Russia’s currency woes have been manifestations of homegrown credit bubbles rather than fickle foreign money flows as consequence to zero bound rates.

Following the global crisis in 2008 Bank Rossii stepped on the interest rate pedal.

The result? Again like anywhere else, from 2008 loans to the private sector has more than doubled. 

This has been accompanied by a near doubling of M2 during the same period.

Part of that credit bubble has been due to Bank Rossii’s foreign currency reserve accumulation. [As a side note, the ruble’s weakness comes amidst a mountain of forex reserves which many mistake as a free lunch to bubbles.]

The build up in foreign exchange reserves has been reflected on the Bank Rossii’s asset growth.

So zero bound rates and Bank Rossii’s forex accumulation has prompted for a credit fueled property boom which supposedly had been one of the “hot” market for real estate in the world in 2013.

While Russia’s housing prices has not reached the pre global crisis of 2007 level (left), housing loans acquired from mostly local institutions have ballooned (middle) to record highs.

And as one would further observe, the gravitation to the real estate boom via housing loans came with declining housing loan rates (right) as charts from Global Property Guide reveal

Zero bound rates has not just been an enticement for the private sector to splurge, the real aim of zero bound rates has been to redistribute of resources from the real economy to the government and to their favored interest groups. This is known as financial repression. Zero bound rates (negative real rates) is just part of the many ways government applies financial repression.

And as proof, while Bank Rossii held rates artificially down, Russia’s local government went into a spending binge.

The Stratfor writes: (bold mine)

Most of Russia's regional governments have always had some level of debt, but resource-based export revenues have kept it mostly manageable since the 1998 crisis. However, since the 2008-2009 financial crisis, most of the regions' debt has risen by more than 100 percent -- from $35 billion in 2010 to an estimated $78 billion in 2014, and Standard & Poor's has estimated that this will rise to $103 billion in 2015. Russia's overall government debt -- the federal and regional governments combined -- is around $300 billion, or 14 percent of gross domestic product. This is small for a country as large as Russia, but the problem is that so much of the debt is concentrated in the regions, which do not have as many debt reduction tools as the federal government does.

Of the 83 regional subjects in Russia, only 20 will be able to keep a budget surplus or a moderate level of debt by 2015, according to Standard & Poor's calculations. This leaves the other 63 regions at risk of needing a federal bailout or defaulting on their debt.

Currently, the Russian regions are financing their debt via bank loans, bonds and budget credits (federal loans, for example). Each region has to get federal approval to issue bonds, because regional bonds create more market competition for the federal and business bonds. Most of the banking loans to the regions carry high interest rates and are short term (mostly between two and five years). The federal loans come with much lower rates and longer repayment schedules (mostly between five and 20 years), so naturally federal credits and loans are more attractive for the local governments, though unprofitable for the federal government. The issuance of federal credits or loans to the regions in 2013 was limited; initially, Moscow said it would issue $4.8 billion in new credits to the regions in 2013, but only issued $2.4 billion due to its own budgetary restrictions. This is one contributing factor to the dramatic local-government debt increases.

In terms of federal external currency debt one may note that Russian foreign liabilities jumped by 34% in just two years. So the devaluing ruble will magnify on the Russia’s external credit risks.

Russia’s major exports has been predominantly commodities, particularly oil, the latter accounts for 71% of total exports in 2012. This has allowed Russian government to post a surplus in both the trade balance and her current account. [note the latter graphs I will not show anymore as this post might exceed the 512k size limits, so pls just click on the links]

Despite the huge foreign reserve, current account surpluses and balance of trade account, Russia has been experiencing private capital outflows since 2008 both from the formal and likewise in the informal sector.

The informal sector has been estimated at 50-65% share of the economy where earlier I pointed out that the Russian government attempted to wage war against this sector by putting limits on cash transactions. Russia, according to Global Financial Integrity (GFI), has been the fifth largest victim of illicit capital outflow notes the RT

In my view, such outflows have partly been consequence to the economic and financial repression which has been reflected by the huge informal sector. Some in the formal and informal sector may have sought monetary refuge or safehaven from the grips of Russia’s autocratic government (e.g Cyprus, Cayman Islands). Some perhaps may have sought alternative investments abroad, and some may have been sensing trouble ahead in the Russian economy.

And symptoms of the latter can be seen via last week’s suspension of cash  withdrawals for a week by ‘My Bank’ supposedly one of Russia’s top 200 lenders by assets, according to the Zero Hedge. 

Some questions: Has this signified the continuing war against the informal economy? But if so, why limit to My Bank? Or has this been signs of a Russian bank in serious trouble? If the latter, has the problems of My Bank been large enough for the Bank Rossii to stay at the sidelines and compel My Bank to take her own measures? Will this not send signals to depositors and investors that Russia’s banking system may be in dire predicament? Could the Bank Rossi’s “unlimited intervention” have been really directed to calm the banking sector or forestall a depositor stampede/bank run?

Interesting twist of events.

In other words, instead of the mainstream’s impression that today’s emerging market rout has been led by foreign money, in Russia’s conditions, the weak ruble and the spike in bond yields 10 year Russian treasuries may have been mostly an exodus of resident money.

And this Wall Street Journal article seems to back my suspicion “High capital outflows have become a sore point in Russia in recent years, with critics saying official corruption is hampering the investment climate and driving money out of the country. The central bank considers debt redemption, dividends paid to foreign shareholders, Russian residents buying foreign currencies, and mergers and acquisitions as capital outflow.”

Bottom line:

One huge foreign reserves, and surpluses in current account and balance of trade account serve as no free pass to bubbles. Russia’s case is just one example

Two contra popular wisdom, it doesn’t take foreign money to pull the trigger for a bust to occur as in the case of Japan in the 1990. While there has hardly been a full credit bust in Russia yet, developing events seem to indicate that Russia’s credit bubble may have already reached its maximum elasticity point (in the face of rising bond yields). And the bubble bust will likely be sparked by a capital flight from resident depositors and investors.

Russia’s plight seems far from over.

Russia’s Vladimir Putin Calls US a ‘Parasite’ Economy

From Reuters,

Russian Prime Minister Vladimir Putin accused the United States Monday of living beyond its means "like a parasite" on the global economy and said dollar dominance was a threat to the financial markets.

"They are living beyond their means and shifting a part of the weight of their problems to the world economy," Putin told the pro-Kremlin youth group Nashi while touring its lakeside summer camp some five hours drive north of Moscow.

"They are living like parasites off the global economy and their monopoly of the dollar," Putin said at the open-air meeting with admiring young Russians in what looked like early campaigning before parliamentary and presidential polls.

As the world’s largest economy that owns the de facto world reserve currency, the US has naturally been taking advantage of this seignorage privilege.

Nevertheless, having abused this position through Keynesian policy induced boom bust cycles and the constant bailouts of the cartelized ‘too big to fail’ banking system, the US dollar’s dominance has been in erosion.

Chart from Wikipedia.org

But Mr. Putin's rants seem to be diverting blame on his country’s woes to the US.

Russia’s autocratic political economy has hardly been a beacon of economic progress worthy of emulation.

chart from the Heritage Foundation

This implies that Mr. Putin holds no moral high ground. It would be like the envious ‘pot calling the kettle black’.

Was the IMF Chief Jailed for Discovering that Gold held by the US has Vanished?

That’s what Russia claims, according to the Eutimes.net

A new report prepared for Prime Minister Putin by the Federal Security Service (FSB) says that former International Monetary Fund (IMF) Chief Dominique Strauss-Kahn was charged and jailed in the US for sex crimes on May 14th after his discovery that all of the gold held in the United States Bullion Depository located at Fort Knox was ‘missing and/or unaccounted’ for.

According to this FSB secret report, Strauss-Kahn had become “increasingly concerned” earlier this month after the United States began “stalling” its pledged delivery to the IMF of 191.3 tons of gold agreed to under the Second Amendment of the Articles of Agreement signed by the Executive Board in April 1978 that were to be sold to fund what are called Special Drawing Rights (SDRs) as an alternative to what are called reserve currencies.

This FSB report further states that upon Strauss-Kahn raising his concerns with American government officialsclose to President Obama he was ‘contacted’ by ‘rogue elements’ within the Central Intelligence Agency (CIA) who provided him ‘firm evidence’ that all of the gold reported to be held by the US ‘was gone’.

Upon Strauss-Kahn receiving the CIA evidence, this report continues, he made immediate arrangements to leave the US for Paris, but when contacted by agents working for France’s General Directorate for External Security (DGSE) that American authorities were seeking his capture he fled to New York City’s JFK airport following these agents directive not to take his cell-phone because US police could track his exact location.

Read the rest here

I wouldn’t know how valid this report is. One thing for sure, whether it is Russia, the US or the IMF, all appears to be dogged by credibility problems.

Price Controls Equals Russia’s Looming Gasoline Shortages

Basic laws of economics always prevail over ‘noble’ political edicts.

That’s how events are turning out in Russia.

From the Wall Street Journal, (bold highlights mine)

The world's biggest oil producer Russia is facing gasoline shortages in some parts of the country, as prices are kept artificially low, leading producers to cash in on higher fuel prices abroad.

Russian car-owners are seeing petrol stations halt operations across the country, following an order by Prime Minister Vladimir Putin in February to investigate steep increases in gasoline prices, which led producers to ship more fuel for exports.

Russia consumes about half of the 10 million barrels it produces a day domestically, but prices on oil products, including gasoline, are kept artificially low. The government's attempt to control gasoline prices is just one of several measures aimed at curbing inflation—a key political issue with elections less than a year away, as higher gasoline prices could hurt Mr. Putin's popularity.

Russia's antimonopoly agency has repeatedly accused the country's top oil producers such as OAO Rosneft, OAO Lukoil Holdings and TNK-BP Ltd. of increasing prices for diesel and jet fuel.

After gasoline prices rose at the end of last year and another 4% in January, Prime Minister Vladimir Putin in February warned the country's top oil executives against price fixing. Mr. Putin accused them of trying to "crudely exact maximum gains" and vowed more oversight of the fuel business, effectively capping prices. As a result, prices declined both in February and March, despite the continued surge in global crude prices.

"The domestic prices are being held artificially low due to pressure from regulatory authorities," TNK-BP's Chief Financial Officer Jonathan Muir said Wednesday.

As we earlier pointed out, the inflation cycle appears to be gradually playing out around the world.

The cycle goes: Government first engages in inflationism. Then government blames these (called as price gouging) on the ‘greed’ of speculators and market players. Finally the government imposes price controls. The effect: Price controls fuel more distortions (via shortages) which translates to more higher prices.

Governments essentially adapts the fallacy of “two wrongs make a right”, when denial only worsens the problem.

It’s vicious cycle practiced over 4 centuries that has always failed, yet political leaders everywhere never ever seem to learn. They are so predictable.

Some Democrats Recognize The Value Of Free Trade

The following data and analysis comes from the website of US Democratic Party [the political party where one would hear a mouthful of anti free trade sentiment], the Democratic Leadership Council.

The article referred herein is about Russia as the largest country outside the WTO, and the prospects of increasing trade relations with her and the US through a membership in the WTO.

Here is the kicker from the DLC.org (bold emphasis mine)

Altogether this would mark the largest burst of economic reforms and liberalizations certainly since Russia's independence in 1991, and likely rival only the perestroika era of the late 1980s as Russia's most ambitious attempt to rejoin the world economy since the First World War and the Revolution.

For the other new WTO members, this has meant big jumps in imports -- America's own export growth to these countries has been double the pace of export growth to new FTA partners and four times the rate to the rest of the world.

Res ipsa loquitor

Desperately Looking For Normal-In Pictures

Here is another demonstration of how massively disconnected the stock markets are with conventional fundamentalism (e.g. economy or earnings)-which is the reason why many "experts" have been utterly perplexed.

Russia's RTSI had been one of the top world performers for 2009 and produced 129% in local currency gains!


The conventional thought have been that stocks function as forward looking indicators for the economy with about a window of 4 to 6 months ahead.

Yet the Russian economy has wobbled ALL throughout last year as shown below from US Global Investors.


According to US Global Investors, ``Russian GDP contraction is estimated to decelerate to -5.3 percent in the fourth quarter compared to -9.8 percent in the third quarter. The beginning of economic recovery as well as the base effect means a substantial upside to 3-4 percent growth estimate in 2010."

The RTSI spiked by another astounding 8% this week!

More.

In our recent post, Venezuela's Path To Hyperinflation we noted that despite the recent crisis-massive devaluation and electricity rationing-Venezuela's stock market benchmark, the IBVC, soared by a whopping 10.85% this week!

Chart From Bloomberg

No, it isn't that Venezuela is immune or crisis proof.

Instead it is likely that we are witnessing accelerated signs of the demonetization process or the trajectory towards hyperinflation.

Bottom line: the common denominator appears to be massive inflationism and how these has mangled economic calculation and has thus resulted to unexpected volatility.

Mark Mobius On Russia's Stock Market: Significant Upside Potential And Remains An Attractive Investment Destination

Emerging Market Guru Mark Mobius of Templeton Funds features Russia in his latest commentary...(bold highlights mine)

``During 2008, Russia was among the weakest stock market performers in the emerging market universe, losing more than 70% in US$ terms. But this year, the market has staged an impressive rally surging nearly 100% in the year-to-October period. The Russian market is among the cheapest in the emerging market universe and is trading at a discount of around 50% to its counterparts.

``Today, Russia and many other emerging markets are now being driven by an excess in money supply in the international markets which means that these markets are experiencing an inflow of money for investments. Consequently, as Russia was more depressed than other markets, the upside is greater. At Templeton, we continue to find attractive opportunities in most sectors despite the recent rally as valuations remain undervalued. The Templeton Emerging Markets team continues to study individual companies and maintain a long-term investment outlook. Of course general factors such as trends in regional consumer expenditure, commodity prices and corporate governance policies are also taken into account.

We believe that Russia’s equity markets are poised to climb significantly higher because even among Russia’s blue chips you can still find undervalued stocks relative to global and sector peers. Take for example, Gazprom and Lukoil. Gazprom is the largest producer of gas in the world by reserves and production. The company’s reserves account for nearly a fifth of the world’s supply. It is also the biggest gas supplier to Europe and makes up for a majority of the gas production in Russia. Its valuations, however, remain extremely attractive with a P/E of just 4.5x and P/BV of 0.9x.

Lukoil is the second largest vertically integrated oil company in Russia and one of the largest in the world in terms of reserves. The company is engaged in exploration, development, production and refining of crude oil and marketing and distribution of crude and oil products. Lukoil is also trading at very attractive valuations with a P/E of 5.3x and P/BV of 1.0x.

However, there are still risks involved with Russia. The short-term risk is a downturn in money supply and a political event which could impact market sentiment while in the longer-term, it is a change in government attitudes towards privatisation and a market economy.

There are some sectors that we prefer over others within Russia. At the moment we like commodities and in particular the oil companies. We also like consumer sector given that it is a growing market in Russia. In particular we are finding good value in consumer products and distribution companies.

In general, our long-term outlook for Russia remains positive. The country has the world’s third largest foreign exchange reserves at more than US$400 billion. Meanwhile, inflation has been trending down and due to timely and adequate support from the government to the domestic banking system, a new equilibrium for the Ruble has been established. As a result, the authorities were able to cut interest rates. Moreover, Russia owns large proportion of the world’s natural resources and many of the country’s commodity companies are among the world’s low-cost producers.

``Last but not least, it is interesting to note that based on current valuations, the Russian market is among the cheapest in the emerging market universe. With Price to Earnings (P/E) of just 9.8x and a Price to Book Value (P/BV) of just 1.2x, the Russian market is trading at a discount of about 50% to its emerging market counterparts. This gap should eventually narrow, which is why we believe that Russia could outperform its emerging market peers in the future. In addition, Russia is also trading at a discount to its BRIC peers (as represented by the MSCI BRIC index), which have a P/E of 15.8x and P/BV of 2.2x. Thus, the Russian market has significant upside potential and remains an attractive investment destination."

Stratfor Video: A Crisis in the Kremlin

Russia seems caught between the clashing interest of political interest groups and the economy.

Stratfor: "A plan to remake Russia's economy threatens to unleash political infighting in Moscow -- upsetting a balance that Prime Minister Vladimir Putin has worked to maintain. If the plan goes through, the implications for industry and investors could be profound." (Hat tip: Stratfor & John Maudlin)

This is an example of the hazards from state capitalism...

Graphic: US Versus Russia

A graphic comparing the US and Russia on various aspects courtesy of mint.com.
See the original plus other graphics at mint.com

BRIC Horse Race: Russia Leads, China Trails

Bespoke Invest shows of the relative (horse racing) performances of BRIC countries.

According to Bespoke, ``After leading the BRIC countries (Brazil, Russia, India, China) in year-to-date performance by a wide margin a few months ago, China is now doing the worst... Russia's stock market is now doing the best in '09 with a gain of nearly 100% (98.5%). India is up the second most at 77.5%, followed by Brazil at 62.4%, and finally China at 52.6%. And while the other three BRIC countries remain in nice uptrends, China looks quite the opposite."

It would appear that Bespoke likes to "pick" on China for unknown reasons.

Nonetheless, we would like to add that Russia's RTSI earlier fell almost 30% from its MAY 2009 high prior to this recent outperformance. So the May decline served as a "bear trap" for any BRIC skeptics.

And considering the still loose monetary environment, China's market via the Shanghai index could replicate Russia's performance.

Ticker tape reading today's activities into the future isn't guaranteed.