Archive for category Business

History Repeats and Shows Inflation Relation

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History Shows That Pinning Fed Funds Below GDP Growth Leads to Rising Inflation Over Time

e = KKR Global Macro & Asset Allocation estimate. Our estimate assumes the Fed does not tighten until mid-2015 and that nominal GDP growth averages 4.5% annually between 2012 and 2014. Data as at March 20, 2014.

Mid-Year Economic Update – 2014

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USA stable but not strong (2.5%), Europe stable but anemic (1.1%), Chinese GDP is lower but still strong (7.3% with ranges from 7.2% to 7.5%), Brazil improving (1.8%, from 1.0% however confidence is waning).  (Bloomberg).

The USA economic recovery is predicted by KKR Global to remain at work until 2017. However, it is not expected that major crisis would result in severe deterioration because the crisis was created in a single sector that grew to bubble proportions, at the moment there is no single sector growing, there is more uniformity (“the worst is over” idea, this time) (KKR Global)

On the longer horizon, the Chinese economy is structurally slowing and changing at the same time.  Exports continues down, internal consumption is increasing, government spending is down, infrastructure projects and investments are increasing.

These are the result of several drivers:

  1. Anti-corruption initiatives;
  2. Forced decline in lending back towards nominal GDP growth; and
  3. Increased competition across many of China’s export due primarily with rising cost of labor.

Manufacturing in Developed Markets is Up While in Emerging Ones is Flat

Shows manufacturing improvement in developed countries (less imports needed) while emerging countries (sources of imports) have reduced manufacturing.  In particular, China’s prior brand as the “Manufacturer of the World”, is no longer the case.  In summary, this chart below shows, more production in develop countries versus less exports in emerging countries, China in particular.

 

Inflation (as measured by CPI) Rising In Emerging Countries Since 2012 While Falling in Developed Countries.

Increase prices of products and labor in emerging countries contributes to increase in production cost of emerging countries making them less competitive compared to developed countries.

Silver on the Move

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As expected, silver has broken UP.  Then resistance is 22.0 level.

 

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With this weekly chart, we see Silver still have a lot of room for growth.  It has already passed strongly the 20.0 level and the next level after 22.0 is 28.0.

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As an additional piece of information, Baltic Index has deteriorated further.

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10 Rules For Success

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  1. Do what you like to do.
  2. Never give up.
  3. Focus your effort.  (Start small and focus)
  4. Make something happen.
  5. Learn how to communicate.
  6. Never rest your laurels.
  7. Be humble.
  8. Give back.
  9. Develop your reputation.
  10. Be thankful.

by David Rubenstein, Founder Carlyle Group

China Economic Update

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China’s economy as previously described is clearly undergoing a significant transition.  Much needed indeed to have sustainable long term growth.  Major trend changes since 2009, is China’s diminished role as the “manufacturer of the world” for low cost.  Major manufacturing continues to migrate to lower cost countries like Indonesia, Vietnam and with the new borders opened to a much larger low cost competitor, Myanmar.

China centrally managed economy is beginning to shift along a long term trend into a market economy which will become more attractive and also more optimum to a broader group of investors.  Particularly, those who have less reliance on government connections. In addition, the clear message of anti-corruption is seen clearly taking effect wide across China.

As President Xi Jinping recently commented, “Every CPC official should keep in mind that all dirty hands will be caught…officials should hold party disciplines in awe and stop taking chances.5” From that you can tell, his message certainly is catching on.

While China can still be considered a centrally managed economy: Thus “China Inc.”, in the macro front, the expectations for high growth are no longer a reality (10% yoy rate of returns were unsustainable and now of the past).  However at the micro level, there exist even better opportunities as the State-Own-Enterprises (SOE’s) become more privatized and less government regulated.  This only means that Small-Medium-Enterprises (SME’s) would have an increase competitive advantage relatively to SOE’s. (in the past 10 years and increasing more toward the last 5 years, SOE’s overshadowed SME’s due to its government-back relationships.  This is about to change as SOE’s and the government itself appears to be seeking a broader range of private investors while reducing the government ownership.

The graph below clearly shows non-SOE performing better to SOE’s.

China and its Government Committed to Improving SOE Performance

While the projections for China’s GDP growth have been reduced repeatedly down from 8% into the high 7% (7.7-7.8%) including some recent sluggish data out of China, the expected growth for the Chinese economy will account for nearly one third of total global growth in 2014, according to Henry McVey, Head of KKR Global Macro & Asset Allocation.

What to Avoid

Avoid emphasis in capital goods, commodity producers, and export related companies.  China will not be considered the major and only low cost manufacturer of the world. Areas that are highly dependent on government business support will also be affected due to major reduction of government spending.

Furthermore, the rate of urbanization (from Rural to Urban) that started in the 1970’s is expected to slow down.  Rural to Urban migrant deceleration will have an impact in overall GDP growth. 

10-Year CAGR (%)

10-Year CAGR (%)

Agriculture %         

Urban Population     :           Real GDP – Non GDP

1970’s

32.6

2.9%

6.2%

7.3%

1980’s

29.4

4.7%

9.3%

15.2%

1990’s

20.5

4.3%

10.4%

18.2%

2000’s

12.4

3.8%

10.5%

15.0%

Data as at December 31, 2009. Source: China National Bureau of Statistics, Haver Analytics.

 

Slowing urbanization also has a direct impact on productivity, which beyond labor force growth is the most important GDP input. As Exhibit 40 shows, increased productivity from local Chinese moving from the country to the city has begun to face more difficult headwinds. To be sure, this decline will not occur overnight, and there is the potential for the Chinese worker to improve productivity. However, given that we are much further along in the urbanization cycle (Exhibits 40 and 41), we expect continued downward pressure in the months and years ahead.

Exhibit 40

China Is Losing the Tailwind of Urbanization

Data as at December 31, 2012. Source: Source: China National Bureau of Statistics, United Nations: World Urbanization Prospects: The 2011 Revision (POP/DB/WUP/Rev.2011/1/F2), KKR Global Macro & Asset Allocation Estimates.

Exhibit 41

Not Surprisingly, Productivity and Real GDP Are Decelerating in Tandem

Data as at October 8, 2013. Source: China National Bureau of Statistics, World Bank, United Nations World Population Prospects, OECD Economic Outlook long-term database estimates for 2020-2050.

Second, as Exhibit 42 shows, there is also an important demographic issue to consider. While China’s total population will not peak until 2030, its working age population actually peaks in 2015. Moreover, its young population (i.e., those aged 15-29) actually peaked in 1991, and are now having an impact on the country’s dependency ratio. This means that its labor force growth will soon turn negative as there are fewer young people entering the work force. The government certainly understands this issue and it is trying to improve it, as evidenced by the recent relaxation of the one-child policy as well as increased social safety net benefits. However, there is no quick fix to the country’s sizeable demographic challenges. So, as we look towards the next five years in China, we believe that the government will have to do a lot more to just maintain, much less improve, its current labor force growth to prevent a further demographic-led growth slowdown (in addition to maintaining social stability).

Exhibit 42

Fewer Young People Entering the Labor Force…

Data as at July 12, 2013. Source: United Nations, Haver Analytics.

Exhibit 43

…and China’s Dependency Ratio is Rising Quickly

The dependency ratio is the ratio of population aged 0-14 and 65+ per hundred of population aged 15-64. Data as at January 3, 2014. Source: United Nations, Haver Analytics.

Third, the law of large numbers has come into play, as China is now simply so much bigger. As a result, it just becomes much harder to maintain such high growth rates off such a large base. All told, the economy grew to US$ 9,264 trillion in 2013 from US$ 1,198 trillion in 2000 (Exhibit 44). Meanwhile, as Exhibit 44 also shows, China’s GDP-per-capita has skyrocketed in recent years. In fact, GDP per capita in China reached US$ 6,569 in 2013 from US$ 941 in 2000, which represents an annualized growth rate of 16.1%.

Exhibit 44

China’s High Growth Rates Will Be Difficult to Maintain

China

Nominal GDP US$

GDP Per Capita US$

Urban Pop (mil)

% Urban Pop’n

Pop’n
15-24 Yr Old Y/y%

Yuan /US$

2000

1,198

941

459

36.2%

0.9%

8.28

2013

9,264

6,569

731

53.7%

-5.3%

6.15

% Chg

673%

598%

59%

1,751bp

-620bp

35%

CAGR

17.0%

16.1%

3.6%

135bp

-48bp

2.3%

U.S.

Nominal GDP US$

GDP Per Capita US$

Urban Pop (mil)

% Urban Pop’n

Pop’n
15-24 Yr Old Y/y%

 

2000

10,290

36,467

223

79.1%

1.5%

 

2013

16,803

53,152

262

82.9%

0.1%

 

% Chg

63%

46%

17%

378bp

-140bp

 

CAGR

3.8%

2.9%

1.2%

29bp

-11bp

 
Data as at January 19, 2014. Source: China National Bureau of Statistics, Federal Reserve Board, BEA, World Bank, IMF, UN.

Fourth, the economy needs to restructure, particularly its large corporations and financial institutions. All told, as Exhibits 45 & 46 show, China’s corporate leverage—as defined by its assets-to-equity-ratio—has increased 55% to 2.27x from 1.53x, and these figures do not include any off-balance sheet, financial services liabilities linked to implicit trust product guarantees. As a result, it now should embark on an important deleveraging cycle, particularly within its sizeable banking sector. This transition will not be growth friendly, as moving back towards an environment where nominal lending growth again runs below nominal GDP will present both growth headwinds and volatility along the way.

Exhibit 45

Pre-crisis, Return on Equity in Emerging Markets Was Higher with Lower Leverage

Jun-07

LTM ROE

LTM Net Margin

Assets-to-Equity

Asset Turnover

China

15.8

13.0

1.53

0.80

Brazil

19.6

13.0

1.85

0.81

India

21.8

11.5

1.98

0.95

U.S.

16.7

9.2

2.90

0.62

Europe

17.2

8.4

4.05

0.50

LTM = Last twelve months. Data as at June 30, 2007. Source: MSCI, Factset Aggregates.

Exhibit 46

Post-crisis, Return on Equity in Emerging Markets Is Lower on Much Higher Leverage

Dec-13

LTM ROE

LTM Net Margin

Assets-to-Equity

Asset Turnover

China

15.2

10.3

2.27

0.65

Brazil

10.5

8.3

2.55

0.50

India

16.1

9.6

2.28

0.73

U.S.

14.6

9.6

2.07

0.74

Europe

10.8

6.0

2.96

0.60

LTM = Last twelve months. Data as at December 31, 2013. Source: MSCI, Factset Aggregates.

In the end, slower structural growth in China represents an important change in an economy that has suffered few setbacks in recent years. To be sure, downshifting in economic growth will create more uncertainty and volatility in the near-to-medium term, but we actually think it could be a long-term positive if a few important conditions are met. First, we believe strong employment growth should be maintained. The good news is that our work shows that there are still more jobs than there are applicants throughout China. Indeed, according to the latest government statistics, the country’s labor market demand-supply ratio rose to 1.10 in 4Q13 from 1.07 in 3Q13, despite growth slowing to 7.7% from 7.8% over the same period (Exhibit 48). This ratio is important because it suggests that unemployment would not surge in a slower growth environment (Exhibit 47). Second, if slower growth brings fewer environmental headwinds, we think it would serve as an important offset to the growing number of Chinese citizens focused on smog, living conditions and excessive waste. This issue is not to be under-estimated as current poor environmental conditions are already creating social discord, particularly in large urban areas. Finally, if slower growth results because of less corruption and excessive lending, we think it could cool some of the social tension that now appears to be bubbling up among low- to middle-income Chinese citizens.

Exhibit 47

Despite Weaker Growth, Demand for Labor Is Still Robust

Data as at 4Q2013. Source: Ministry of Human Resources and Social Security of China, Haver Analytics.

Exhibit 48

Urban Job Growth Has Remained Strong, Despite Slower GDP Growth

Data as at December 31, 2013. Source: China National Bureau of Statistic, Haver Analytics.

CONCLUSION:

2014 should again, we believe, be a year of substantial repositioning in China, particularly as it relates to the country’s economic drivers. Consistent with this view, Chinese Premier Li Keqiang recently noted that, “As the economy enters a phase of transformation, the slowdown of its prospective growth and moderation of the Chinese economy from a high speed to a medium to high speed are only natural.8

Against this macro backdrop, we think that there are several important considerations worthy of investor attention. First, if we are right on the changing macro backdrop for China, it means that investors should continue to avoid capital goods, commodity producers and export stories related to China as the low cost “manufacturer to the world.” As we detailed in this report, both higher wages and a more robust currency are major structural headwinds. However, services-based industries, including healthcare and wellness, by comparison, still have lots of running room, we believe. Second, we think the new government’s anti-corruption focus is likely to gain, not lose momentum, and as such, investors should make sure not to allocate capital towards businesses that are exposed to anti-corruption initiatives.

Exhibit 49

Strong Economic Growth in China Has Not Rewarded Many Investors

Data above is an index of returns for China Real GDP and China A Shares from 2000 to 2013, with 2000 equaling 100. Data as at December 31, 2013. Source: China National Bureau of Statistics, Shanghai Stock Exchange, Haver Analytics.

Exhibit 50

By Comparison, In the U.S. the Story Has Been Quite the Opposite

Data above is an index of returns for U.S, Real GDP and U.S. S&P 500 from 2000 to 2013, with 2000 equaling 100. Data as at December 31, 2013. Source: Bureau of Economic Analysis, Standard & Poor’s, Haver Analytics.

Exhibit 51

If China Can Improve Its SOEs, the Upside Is Now Much More Significant

Data as at February 4, 2014. Source: Factset Aggregates, MSCI.

Exhibit 52

On the Other Hand, Many Non-SOE Companies Now Look More Fully Valued On a Relative Basis

Data at February 11, 2014. Source: Bloomberg.

Third, while we have lowered our forecast for GDP this year, our research and our on the ground due diligence give us confidence that growth is slowing, not falling off a cliff. However, the longer-term growth trajectory is clearly down – and potentially more quickly than some folks now think. This viewpoint is significant as China is expected to account for 32% of total global growth and 54% if you include its Asian brethren, many of which draft off China (Exhibit 16). Fourth, we should take comfort that the increased movement towards market-based initiatives will ultimately be constructive for Chinese capital markets. As we mentioned above though, this transition is likely to be bumpy along the way. Fifth, if the government executes on its plan, then SOEs, including both its banks and non-financial corporations, could – over time – become more attractive investments, particularly given their current low valuations. Given that China has been one of the fastest growing but worst performing stock markets for quite some time, this would represent a significant shift in the macro landscape.

1 Data as at December 31, 2013. Source: China Customs, Haver Analytics.

2 China Twelve Five Year Plan and China Health Statistics Yearbook 2012.

3 Data as at December 31, 2012. Source: IMF, Haver Analytics.

4 Ibid.3.

5 http://english.peopledaily.com.cn/90785/8512639.html

6 Data as at December 31, 2012. Source: The People’s Bank of China, Haver Analytics.

7 Data as at September 30, 2013. Source: CIMB Malaysia.

8 http://news.xinhuanet.com/english/china/2013-09/11/c_132712448.htm

Important Information

The views expressed in this publication are the personal views of Henry McVey of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) and do not necessarily reflect the views of KKR itself. This document is not research and should not be treated as research. This document does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of KKR. This document is not intended to, and does not, relate specifically to any investment strategy or product that KKR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own views on the topic discussed herein.

The views expressed reflect the current views of Mr. McVey as of the date hereof and neither Mr. McVey nor KKR undertakes to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKR, and may not be reflected in the strategies and products that KKR offers, including strategies and products to which Mr. McVey provides investment advice on behalf of KKR. It should not be assumed that Mr. McVey will make investment recommendations in the future that are consistent with the views expressed herein, or use any or all of the techniques or methods of analysis described herein in managing client accounts. KKR and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this document.

This publication has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this document has been developed internally and/or obtained from sources believed to be reliable; however, neither KKR nor Mr. McVey guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.

There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Target allocations contained herein are subject to change. There is no assurance that the target allocations will be achieved, and actual allocations may be significantly different than that shown here. This publication should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.

The information in this publication may contain projections or other forward‐looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Performance of all cited indices is calculated on a total return basis with dividends reinvested. The indices do not include any expenses, fees or charges and are unmanaged and should not be considered investments.

The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely.

Neither KKR nor Mr. McVey assumes any duty to, nor undertakes to update forward looking statements. No representation or warranty, express or implied, is made or given by or on behalf of KKR, Mr. McVey or any other person as to the accuracy and completeness or fairness of the information contained in this publication and no responsibility or liability is accepted for any such information. By accepting this document, the recipient acknowledges its understanding and acceptance of the foregoing statement.

The MSCI sourced information in this document is the exclusive property of MSCI Inc. (MSCI). MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

 

Slowing urbanization also has a direct impact on productivity, which beyond labor force growth is the most important GDP input. As Exhibit 40 shows, increased productivity from local Chinese moving from the country to the city has begun to face more difficult headwinds. To be sure, this decline will not occur overnight, and there is the potential for the Chinese worker to improve productivity. However, given that we are much further along in the urbanization cycle (Exhibits 40 and 41), we expect continued downward pressure in the months and years ahead.

Exhibit 40

China Is Losing the Tailwind of Urbanization

Data as at December 31, 2012. Source: Source: China National Bureau of Statistics, United Nations: World Urbanization Prospects: The 2011 Revision (POP/DB/WUP/Rev.2011/1/F2), KKR Global Macro & Asset Allocation Estimates.

Exhibit 41

Not Surprisingly, Productivity and Real GDP Are Decelerating in Tandem

Data as at October 8, 2013. Source: China National Bureau of Statistics, World Bank, United Nations World Population Prospects, OECD Economic Outlook long-term database estimates for 2020-2050.

Second, as Exhibit 42 shows, there is also an important demographic issue to consider. While China’s total population will not peak until 2030, its working age population actually peaks in 2015. Moreover, its young population (i.e., those aged 15-29) actually peaked in 1991, and are now having an impact on the country’s dependency ratio. This means that its labor force growth will soon turn negative as there are fewer young people entering the work force. The government certainly understands this issue and it is trying to improve it, as evidenced by the recent relaxation of the one-child policy as well as increased social safety net benefits. However, there is no quick fix to the country’s sizeable demographic challenges. So, as we look towards the next five years in China, we believe that the government will have to do a lot more to just maintain, much less improve, its current labor force growth to prevent a further demographic-led growth slowdown (in addition to maintaining social stability).

Exhibit 42

Fewer Young People Entering the Labor Force…

Data as at July 12, 2013. Source: United Nations, Haver Analytics.

Exhibit 43

…and China’s Dependency Ratio is Rising Quickly

The dependency ratio is the ratio of population aged 0-14 and 65+ per hundred of population aged 15-64. Data as at January 3, 2014. Source: United Nations, Haver Analytics.

Third, the law of large numbers has come into play, as China is now simply so much bigger. As a result, it just becomes much harder to maintain such high growth rates off such a large base. All told, the economy grew to US$ 9,264 trillion in 2013 from US$ 1,198 trillion in 2000 (Exhibit 44). Meanwhile, as Exhibit 44 also shows, China’s GDP-per-capita has skyrocketed in recent years. In fact, GDP per capita in China reached US$ 6,569 in 2013 from US$ 941 in 2000, which represents an annualized growth rate of 16.1%.

Exhibit 44

China’s High Growth Rates Will Be Difficult to Maintain

China

Nominal GDP US$

GDP Per Capita US$

Urban Pop (mil)

% Urban Pop’n

Pop’n
15-24 Yr Old Y/y%

Yuan /US$

2000

1,198

941

459

36.2%

0.9%

8.28

2013

9,264

6,569

731

53.7%

-5.3%

6.15

% Chg

673%

598%

59%

1,751bp

-620bp

35%

CAGR

17.0%

16.1%

3.6%

135bp

-48bp

2.3%

U.S.

Nominal GDP US$

GDP Per Capita US$

Urban Pop (mil)

% Urban Pop’n

Pop’n
15-24 Yr Old Y/y%

2000

10,290

36,467

223

79.1%

1.5%

2013

16,803

53,152

262

82.9%

0.1%

% Chg

63%

46%

17%

378bp

-140bp

CAGR

3.8%

2.9%

1.2%

29bp

-11bp

Data as at January 19, 2014. Source: China National Bureau of Statistics, Federal Reserve Board, BEA, World Bank, IMF, UN.

Fourth, the economy needs to restructure, particularly its large corporations and financial institutions. All told, as Exhibits 45 & 46 show, China’s corporate leverage—as defined by its assets-to-equity-ratio—has increased 55% to 2.27x from 1.53x, and these figures do not include any off-balance sheet, financial services liabilities linked to implicit trust product guarantees. As a result, it now should embark on an important deleveraging cycle, particularly within its sizeable banking sector. This transition will not be growth friendly, as moving back towards an environment where nominal lending growth again runs below nominal GDP will present both growth headwinds and volatility along the way.

Exhibit 45

Pre-crisis, Return on Equity in Emerging Markets Was Higher with Lower Leverage

Jun-07

LTM ROE

LTM Net Margin

Assets-to-Equity

Asset Turnover

China

15.8

13.0

1.53

0.80

Brazil

19.6

13.0

1.85

0.81

India

21.8

11.5

1.98

0.95

U.S.

16.7

9.2

2.90

0.62

Europe

17.2

8.4

4.05

0.50

LTM = Last twelve months. Data as at June 30, 2007. Source: MSCI, Factset Aggregates.

Exhibit 46

Post-crisis, Return on Equity in Emerging Markets Is Lower on Much Higher Leverage

Dec-13

LTM ROE

LTM Net Margin

Assets-to-Equity

Asset Turnover

China

15.2

10.3

2.27

0.65

Brazil

10.5

8.3

2.55

0.50

India

16.1

9.6

2.28

0.73

U.S.

14.6

9.6

2.07

0.74

Europe

10.8

6.0

2.96

0.60

LTM = Last twelve months. Data as at December 31, 2013. Source: MSCI, Factset Aggregates.

In the end, slower structural growth in China represents an important change in an economy that has suffered few setbacks in recent years. To be sure, downshifting in economic growth will create more uncertainty and volatility in the near-to-medium term, but we actually think it could be a long-term positive if a few important conditions are met. First, we believe strong employment growth should be maintained. The good news is that our work shows that there are still more jobs than there are applicants throughout China. Indeed, according to the latest government statistics, the country’s labor market demand-supply ratio rose to 1.10 in 4Q13 from 1.07 in 3Q13, despite growth slowing to 7.7% from 7.8% over the same period (Exhibit 48). This ratio is important because it suggests that unemployment would not surge in a slower growth environment (Exhibit 47). Second, if slower growth brings fewer environmental headwinds, we think it would serve as an important offset to the growing number of Chinese citizens focused on smog, living conditions and excessive waste. This issue is not to be under-estimated as current poor environmental conditions are already creating social discord, particularly in large urban areas. Finally, if slower growth results because of less corruption and excessive lending, we think it could cool some of the social tension that now appears to be bubbling up among low- to middle-income Chinese citizens.

Exhibit 47

Despite Weaker Growth, Demand for Labor Is Still Robust

Data as at 4Q2013. Source: Ministry of Human Resources and Social Security of China, Haver Analytics.

Exhibit 48

Urban Job Growth Has Remained Strong, Despite Slower GDP Growth

Data as at December 31, 2013. Source: China National Bureau of Statistic, Haver Analytics.

CONCLUSION:

2014 should again, we believe, be a year of substantial repositioning in China, particularly as it relates to the country’s economic drivers. Consistent with this view, Chinese Premier Li Keqiang recently noted that, “As the economy enters a phase of transformation, the slowdown of its prospective growth and moderation of the Chinese economy from a high speed to a medium to high speed are only natural.8

Against this macro backdrop, we think that there are several important considerations worthy of investor attention. First, if we are right on the changing macro backdrop for China, it means that investors should continue to avoid capital goods, commodity producers and export stories related to China as the low cost “manufacturer to the world.” As we detailed in this report, both higher wages and a more robust currency are major structural headwinds. However, services-based industries, including healthcare and wellness, by comparison, still have lots of running room, we believe. Second, we think the new government’s anti-corruption focus is likely to gain, not lose momentum, and as such, investors should make sure not to allocate capital towards businesses that are exposed to anti-corruption initiatives.

Exhibit 49

Strong Economic Growth in China Has Not Rewarded Many Investors

Data above is an index of returns for China Real GDP and China A Shares from 2000 to 2013, with 2000 equaling 100. Data as at December 31, 2013. Source: China National Bureau of Statistics, Shanghai Stock Exchange, Haver Analytics.

Exhibit 50

By Comparison, In the U.S. the Story Has Been Quite the Opposite

Data above is an index of returns for U.S, Real GDP and U.S. S&P 500 from 2000 to 2013, with 2000 equaling 100. Data as at December 31, 2013. Source: Bureau of Economic Analysis, Standard & Poor’s, Haver Analytics.

Exhibit 51

If China Can Improve Its SOEs, the Upside Is Now Much More Significant

Data as at February 4, 2014. Source: Factset Aggregates, MSCI.

Exhibit 52

On the Other Hand, Many Non-SOE Companies Now Look More Fully Valued On a Relative Basis

Data at February 11, 2014. Source: Bloomberg.

Third, while we have lowered our forecast for GDP this year, our research and our on the ground due diligence give us confidence that growth is slowing, not falling off a cliff. However, the longer-term growth trajectory is clearly down – and potentially more quickly than some folks now think. This viewpoint is significant as China is expected to account for 32% of total global growth and 54% if you include its Asian brethren, many of which draft off China (Exhibit 16). Fourth, we should take comfort that the increased movement towards market-based initiatives will ultimately be constructive for Chinese capital markets. As we mentioned above though, this transition is likely to be bumpy along the way. Fifth, if the government executes on its plan, then SOEs, including both its banks and non-financial corporations, could – over time – become more attractive investments, particularly given their current low valuations. Given that China has been one of the fastest growing but worst performing stock markets for quite some time, this would represent a significant shift in the macro landscape.

1 Data as at December 31, 2013. Source: China Customs, Haver Analytics.

2 China Twelve Five Year Plan and China Health Statistics Yearbook 2012.

3 Data as at December 31, 2012. Source: IMF, Haver Analytics.

4 Ibid.3.

5 http://english.peopledaily.com.cn/90785/8512639.html

6 Data as at December 31, 2012. Source: The People’s Bank of China, Haver Analytics.

7 Data as at September 30, 2013. Source: CIMB Malaysia.

8 http://news.xinhuanet.com/english/china/2013-09/11/c_132712448.htm

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The views expressed in this publication are the personal views of Henry McVey of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) and do not necessarily reflect the views of KKR itself. This document is not research and should not be treated as research. This document does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of KKR. This document is not intended to, and does not, relate specifically to any investment strategy or product that KKR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own views on the topic discussed herein.

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What to Look For

Valued-added businesses, internet based businesses and ecommerce, services-based industries, like healthcare, hospitality, food & beverage and wellness.

The focus of the government’s into anti-corruption will likely gain momentum and be the next trend.  Shanghai and other major cities in China have added armed police to ensure rapid response to social unrest.

Moving Toward Higher Value Manufacturing

The following chart from the World Trade Organization shows areas of saturation and areas of opportunities.

Basically, China controls today 41%, 38% and 33%, respectively, of the entire global market share in clothing & textile, and electronic components.

China Trading with Emerging Countries Growing

China continues to strengthen its economic and trading ties through Asia (as a wise strategic move) and somewhat to the rest of the developing world.  Global growth (in GDP) is expected to come from emerging economies, (ie not from develop countries like U.S. UK or Europe) for 2014 the next couple of years.

China in 2014 will represent 32% (1/3) of total Global GDP Growth compared with the USA which is approximately 0.5% and Europe to be 0.1%.

Source: IMF, Haver Analytics.

In addition, China’s exports to emerging countries have increased thirty-fold (30 times) since 1995 versus just an eleven-fold increase to the developed world over the same period according to the IMF (IMF, Haver Analytics).

Chinese exports to developing countries are now 32% of its total exports versus just 15% in 1995. More importantly is that exports to emerging countries in Asia (ex-Japan) are fast approaching the exports to the USA.  Lessening the dependency on USA exports.  Asia emerging Asia are now 11.4% of total exports, which is now higher than China exports to Japan (7.4% of total exports) and fast reaching the exports from China to the United States (17% of total).

China Consumption Is Growing

While the growth of consumption in the USA has reduced to 4.1%, China consumption growth has outpaced that of the USA to 13.8%.

In fact, China’s consumption growth has also been much higher relative to its Asian brethren and other emerging markets. China’s real consumption growth during the 2000-2012 period averaged 8.7% versus 6.4% for India, 4.4% for Indonesia and 7.3% for Malaysia, respectively, over the same period.

In the USA, the personal consumption (Household Consumptions) as percent of GDP is 69% compared to China which is 35%. (according the the World Bank, 2013).

Household consumption expenditure (formerly private consumption) is the market value of all goods and services, including durable products (such as cars, washing machines, and home computers), purchased by households. It excludes purchases of dwellings but includes imputed rent for owner-occupied dwellings

Although internal consumption engine in China is growing faster than any other country, the rebalancing of China’s heavy export dependency with a larger internal consumption is not going to be quick. As a matter of fact, it may take at least 12 to 18 years.  More practical is China’s ability to change low value exports into value added exports, a possible 5-8 years process.

And we expect that this internal consumption growth if without major infrastructure and resource changes will result in lower GDP Growth as present face value.  Today at 35%, with an increase in internal consumption to 36%, the increase the GDP growth would be increased to 9.2% however above 48% of GDP, the growth contribution decelerates rapidly.

Paper Currency – Summary History

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This article is worth reading…As it shows how paper money is designed to depreciate over time.

The History of Paper Currency
By Eric Tilden, eHow Contributor

The History of Paper Currency
The history of paper currency is rooted in the monetary exchange system, which replaced bartering for goods. Coins created with a specific amount of gold, silver or bronze established a uniform measurement of exchange, which was difficult to transport because of the weight. In the 19th century, paper money began appearing to replace varying coin systems, often as a result of regime changes but sometimes because of war. Early paper money was placed on the gold or silver standard, which allowed equal exchange of gold for the value printed on the paper.
China
o
The Chinese government, under the Sung dynasty, issued the first official paper money, which had an expiration date, was in short supply and was limited to select areas. The government required the money’s replacement every three years, charging the person a 3 percent service charge in order to exchange it for new money. The old money was never retired or destroyed, however, leading to rampant inflation by 1106. The Yuan dynasty abolished the expiration of the money, allowed the paper to equal hard commodity rates such as gold, silver and silk, and transitioned the old Sung currency to its own currency. This dynasty also abolished the use of metal currency in favor of the paper currency and demanded that taxes be paid in paper currency. An internal war caused rampant inflation and collapsed the currency altogether, leading to its total disappearance by 1500. In the 1890s, banknotes were issued based on the yuan, which was on the silver standard. The country issued currency through its banks, which led to differing currencies in the 1930s along with the Japanese who invaded at that time. Since 1948, China has been on the gold standard, calling its currency the gold yuan.
2. Scotland
o
The Bank of Scotland, established in 1695, issued 5, 10, 50 and 100 shilling banknotes, beginning its business ventures by making commercial loans and doing business with only the very wealthy. The bank introduced a 20-shilling banknote in 1704. Unlike modern paper money, these banknotes looked more like checkbooks without the perforated edge. The Scots were the first to incorporate color into their money in 1777.
3. Germany
o
In 1873, Germany issued its first paper currency, calling it the gold mark. German paper currency was called the papiermark, beginning in 1914 as the mark lost its link with gold because of World War I. In 1924, Germany introduced the reichsmark, replacing the papiermark because of the rising inflation. Because the value of a reichsmark was worth 1 trillion papiermarks, a rentenmark bridged the gap, which was based on the gold standard. In 1948, the United States, France and Great Britain issued the Deutsche mark to West Germany, replacing the reichsmark and rentenmark. The Soviets issued their version of the Deutsche mark later that year. In 1990, after the collapse of the Soviet Union, the West German Deutsche mark helped unify the country. In 2001, Germany joined the European Union, replacing the Deutsche mark with the euro.
4. Japan
o
In 1872, attempting to establish a standard type of money, the Meiji government established the first, widely accepted paper currency called the yen. The yen adopted the gold standard, and the first banknotes resembled U.S. banknotes. After World War I, the yen was tied to the value of the U.S. dollar, until 1973 when the United States abandoned the gold standard. As of 2007, the value of the yen has been kept low as the Japanese economy focuses on high exports, low interest rates and policies that strictly regulate inflation.
5. United States
o
The Massachusetts Bay Colony issued the first paper money on American soil in 1690. In 1775, the Continental Congress issued paper currency–called continentals–to pay for the Revolutionary War. Instead of backing the paper money’s value with precious metals, the money was backed with anticipated tax revenues, which led to counterfeiting and devaluation. Established in 1791, the first bank of the United States issued banknotes to eliminate confusion and simplify trade. In 1861, Congress authorized the United States Treasury to issue paper money called demand notes, which were non-interest-bearing, in order to pay for the Civil War. In 1865, the U.S. Treasury issued gold certificates against gold bullion deposits, taking them out of circulation in 1933. In 1877, the U.S. Treasury took over all printing and engraving in 1877. In 1973, the Unites States departed from the gold standard.

Recycling Trend Setting

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The trend toward recycling is taking shape and eWaste stand leading the revolution. This has been one of our major predictions since 2000.  The enormous and insatiable use of natural raw material started by the consumerism trend in the USA and overflowing to emergent economies with billions of inhabitants of disposable income will meet with natural supply obstacles.  Recycling is innevitable!

And here is a news article to the above.

US Military Building Space Robot to Recycle Satellites (Video)

By Mike Wall | SPACE.com – 1 hr 23 mins ago

DARPA Phoenix program

Defense Advanced Research Projects …

A Pentagon project to harvest and reuse parts from dead satellites is gaining steam, and a new video shows how the far the military program has come in its first few months.

The new video serves as a progress report through last November for the Phoenix program, a project by the Defense Advanced Research Projects Agency (DARPA) to recycle space junk back into valuable satellite parts, or even completely new spacecraft. DARPA scientists began the project in July and are working toward launching the first demonstration mission in two years or so.

“Today, satellites are not built to be modified or repaired in space,” Phoenix program manager Dave Barnhart said in a statement unveiling the video Tuesday (Jan. 22). “Therefore, to enable an architecture that can reuse or repurpose on-orbit components requires us to create new technologies and new capabilities. This progress report gives the community a better sense of how we are doing on the challenges we may face and the technologies needed to help us meet our goals.” 

An animation of a Phoenix servicing spacecraft working on orbit runs in the background of the 2 1/2-minute video. The foreground, meanwhile, shows some of the progress that has been made in the lab to date. [DARPA’s Project Phoenix (Video)]

This progress includes the development and testing of prototype satellite-grappling technology and tele-operations control software, among other gear, according to the video.

The Phoenix program plans to use a robot mechanic to grab still-working antennas from the many retired and dead satellites in geosynchronous orbit, about 22,000 miles (35,406 kilometers) above Earth. These large, bulky antennas would then be attached to small “satlets,” or nanosatellites, launched from Earth, creating new space systems on the cheap.

The goal is to demonstrate a way to turn part of the ever-expanding cloud of space junk around our planet into space resources, saving money in the process, DARPA officials have said. The first on-orbit demonstration mission is targeted for 2015.

“We have a long way to go, but we are laying the foundation for improving how we build space systems, with the goal of changing the economic model for space operations,” Barnhart said.

Phoenix isn’t the only satellite-servicing effort currently underway. NASA’s Robotic Refueling Mission (RRM), which was delivered to the International Space Station in July 2011, is testing out the technology necessary to repair and refuel satellites on orbit.

The latest round of RRM experiments is going on right now, with the space station’s two-armed Dextre robot attempting to snip wires, unscrew caps and pump simulated fuel using the RRM test module, NASA officials have said.

 

BASILIO CHEN H.
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Action Versus Words

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This will be one of my few completely philosophical anecdotes in my writing however like all writing it serves a purpose – to educate the one who wants to be educated and wants to be educated to excel to the extreme!

I am in China at the moment but what I am about to write about applies practically in all places I have been: the USA, Europe, Asia and I can imagine it applies more so in Africa and the Middle East.

Traditions and beliefs sets most average thinkers and while enjoyable as part of a grander culture, it comes the times that one has to make a clear decision to live in both worlds.  One where there is tradition on the other hand think outside of the common tradition.

If you want to be extremely successful that itself by definition means you are not average.  And if you seek common knowledge from the average person to become successful, isn’t that contradictory.  Or worst than that you have to ask if that keeps up being an average person.

Most traditions keep you from taking actions outside of the traditions.  China became an economic success story in grand proportion because modern China eliminated and eradicated tradition allowing Chinese to act outside of their prior norms.  (Undoubtedly, tradition will set back in again and you can expect a natural return to the norm in time).

Taking action to meet the objective becomes the only rule that matters.

Have a goal and take action without hinderances (except to obey local laws).

 

Quantum Leap Story – Inspiring to the Real Entrepreneur

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There is more to learn in this article than what any MBA at any university teaches.

“Billionaires do not become billionaires by getting into a diversified mutual fund or investing in an ETF or investing in the S&P Index Fund,” Miller tells The Daily Ticker. “You get rich by building equity in a very concentrated position that is typically one big company.”

Most billionaires are also in the retail or commodity industries, he says. “Retail is a huge presence,” Miller notes, adding that 26 billionaires on Bloomberg’s list started their careers in retail.

Twenty-two billionaires on the list have made their fortunes in technology, and 14 are a part of a family business (ie thru inheritance or marrying a rich man).

The story is here (appeared in the Bloomberg Billionaire Index)

Money can’t buy happiness goes the old adage, but if it could Amancio Ortega would be floating on cloud nine.

Ortega is a relatively obscure 76-year-old retail magnate and founder of the Spanish company Inditex SA. Inditex owns and operates various clothing brands with over 5,402 stores around the globe; the crown jewel of Inditex is Zara, which has over 1,600 store locations.

Between January and October of 2012, Ortega earned more than $18 billion — that’s around $66 million a day. During this short period he usurped Warren Buffett to become the third wealthiest person in the world with a net worth valued at $53.6 billion.

Ortega was born to a impoverished railway worker and had to drop out of school at 13 to work. He began as a delivery boy for a clothing shop and worked his way up to become a salesperson. While working retail Ortega had the idea to sell inexpensive versions of quilted bathrobes, claiming it was unfair that only wealthy woman could afford to dress well. He used this as the founding principle behind the rest of his retail ventures and built his empire on top of it.

Ortega’s rapid gain corresponds with a general rise in retail stocks. Cheap supplies and increasing demand for moderately priced clothing have made it a good year for retailers. Nine out of the world’s 25 richest people made their fortunes in retail, according to the Bloomberg Index.

Physics tells us that what goes up must come down and unfortunately that’s exactly what happened to some billionaires’ fortunes this year.

Ricardo Salinas Pliego who runs Grupo Elektra in Mexico is the biggest loser on the list. Pliego lost $9.1 billion year-to-date. His net worth is now $11.7 billion, making him the eightieth richest person in the world. The banking and media tycoon has seen the value of his stock holdings nearly cut in half since April 2012.

Another famous loser is Facebook’s Mark Zuckerberg.

Before Facebook’s IPO, Zuckerberg was estimated to be worth up to $20 billion. The social network’s stock has underperformed since its May stock market debut Zuckerberg’s net worth has dropped by $10.7 billion. But he’s still the world’s 88th richest person.

SURPRISE ADDITIONS

Bloomberg was able to uncover ten new billionaires who had never before been on an international wealth ranking.

Dirce Navarro de Camargo has become Brazil’s wealthiest woman after inheriting her late husband’s industrial empire, Camargo Correa SA. Camargo is the world’s 60th richest person with a net worth of $13.1 billion.

Elaine Marshall owns a 15% stake in Koch Industries, with a net worth of $12.9 billion. She ranks as the 69th richest person in the world. Marshall, who is America’s 4th richest woman, inherited the shares from her late husband, E. Pierce Marshall.

Marshall’s last public appearance was in 1994 when her father-in-law’s widow, Anna Nicole Smith, became entangled in a long legal battle over his trust. Marshall was ultimately granted his shares in Koch and now lives a quiet life in Dallas, Texas.

LEARNING FROM BILLIONAIRES

“Billionaires do not become billionaires by getting into a diversified mutual fund or investing in an ETF or investing in the S&P Index Fund,” Miller tells The Daily Ticker. “You get rich by building equity in a very concentrated position that is typically one big company.”

Most billionaires are also in the retail or commodity industries, he says. “Retail is a huge presence,” Miller notes, adding that 26 billionaires on Bloomberg’s list started their careers in retail.

Twenty-two billionaires on the list have made their fortunes in technology, and 14 are a part of a family business.

Overall, “it’s been a great year for billionaires,” Miller says. “If you look at the top 100 everyday, traditionally they’ve been up. The S&P is up for the year and private fortunes track public markets.”

The necessary teachings to become one of these tycoon are not taught in school but are neither inherited and are also irrespective of actual conditions.  Starting early helps!

Europe Economic Update – October 2012

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The EU Zone flash composite PMI misses it estimate and falls to 45.8 to a 40-month low. Flash manufacturing PMI falls from 46.1 to 45.3, below expectation.  Service sector rises from 46.1 to 46.2 a very marginal – if any – rise, also below expectation.

image

Germany’s manufacturing PMI fell from 47.4 to 45.7, much worse than expectated.  Services also remain rather unchanged services but with a slight fall from 49.7 to 49.3, also below expectation. On the other side, France’s manufacturing PMI rises from 42.7 to 43.5, but also below expectation.  Services rises from 45.0 to 46.2, better than expectation.

 

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