Happy New Year

2006 is over.
Today is the second day of 2007. I spend some time now to think about what mistake(s) I have done and what I should avoid.

The obvious mistake I have made is I am too impatient. I thought the world will move faster. At the beginning of 2006, I recalled I said 2006 is a critical year. Rebalance will start in a systematic and consistent way. Dollar will depreciate, global liquidity will evaporate. Emerging markets will be tested. Mexico will suffer from the trade linkage with the US. Brazil, with fundamental changes, will hold well relatively. Japan will start to play an important role in dollar rebalancing. Euro will not be as dynamic as the Asian currencies (including Yen), due to its internal problems. The results? Dollar continues to hold up, global liquidity continues to be high, Mexico is doing well and stable, its trade with the US maintains well. Yen did not appreciate, but Euro did.

I am too impatient. The world does not move fast enough to materialize the predictions (not sure if it will eventually). Japan’s growth and inflation dynamic is slowly evolving. Reserve diversification has not been strong enough to trigger the dollar collapse. The US housing market is slowing down quickly, but its ripple impact is insignificant so far. I should remind myself from time to time that the business cycle is a parabola, mostly likely without any kinks. So, the slow evolving in 2006 represents the movement from the peak. Looking forward, 2007 (again) is a critical year. The negative momentums have accumulated in 2006. The speed of global rebalancing should rise.

When I talked to a few academias in the past year, one common thing they found was that the market is over optimistic to the economy. I have to admit that they said the same thing in 2005 or even before, and there is a professional bias - you become famous if you can “predict” a crisis. The important lesson is that we really don’t know when (if any) the trigger will happen, but I think it is convincing enough it will happen as our baseline.

What I think about the theme in 2007.

Some people believe inflation in the US is the major risk. They also believe 2H 2007 will be a positive turning point for the US. I believe inflation is not the major risk. I believe 2H 2007 will not be the positive turning point for the US. Here is my reasoning. I believe the global economy is going to moderate. Oil price will not be as high as we saw in the past year. I believe protectionism may prevail, but the impacts on “import” inflation will not be high. I believe businessmen are clever enough to find their way out from protectionism. I believe they have the capacity and flexibility to switch their production fast enough from high cost countries to low cost countries. I believe the fed will stay neutral so that inflation from monetary stimulus will not be exaggerated.

On the other hand, as I mentioned momentum has established in 2006. I expect the market will move faster in 2007. The economy in the US will continue to slow down. Some ripple effect from housing will be felt in other sectors. Once we reach this point, one the market convinces that fed will not raise the rate, dollar will react.

I believe many EM, especially Asia will be able to decouple from the moderation of the US. As mentioned in the previous blog, many emerging economies are able to put their houses in shape in the past years. Now, external risks are lower than before. They worry more FX appreciation than depreciation. They worry too much capital inflows more than capital outflows. They worry too much international reserve more than too little international reserve. They worry the crisis from the slow down of US economy than from their own economies.

I believe many EMs will be able to hold up their own economies by increasing their government expenditure and domestic investment. I believe indeed, it is a good time/opportunity for them to take advantage the US moderation to gear up their domestic consumption capacities. Furthermore, with trade globalization, I believe consumption substitution effect will be taken place as well. BMW and Mercedes imports will be substituted by Toyota and Hyundai. Boomingdale’s consumption will be substituted by JC Penny, etc. The impact on low cost Asia countries should not be as bad as many investors’ expected.

Cross fingers and be patient.

Happy new year

Side note:
One of my friends just got birth to a new born baby. I went to Walmart and Target, shopping for some little clothes for the baby. What is interesting to see is those clothes are all made in non-US countries. More importantly, they are quite diversified from China, India, Pakistan, Costa Rica, Vietnam, etc. Unless we have a global protectionism, businessmen are flexible enough to get us a good deal.