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100 weeks have passed since it was blindingly obvious that a total over-haul of financial regulation was required and the latest government sponsored report, from the Treasury Select Committee, has described the current supervisory framework as a “muddle”. The committee also suggested that the measures to date were “merely re-branding” and that there remains a void of ownership in “strategic decisions and executive action”. They are not referring to the old system. They are describing the current structure.

Britain wasn’t always a 2nd class nation in terms of financial and economic leadership. 80 years ago we were lucky enough to have possibly the most gifted economist that ever lived, John Maynard Keynes, to advise the government on economic and financial matters.

The world’s largest economy has now shrunk for four consecutive quarters, the longest losing sequence since records were formalised in 1947.

A key contributor to the latest decline was the erosion of business inventories which slumped by a record $140bn in the quarter as firms cut production in an effort to reduce stockpiles. The production cut-backs contributed about 80% of the Q2 contraction in economic activity.

Exports, residential and business investment all fell though the rate of decline in each sector slowed compared to the 1st quarter.

The GDP report came at the end of another week of appreciating equity prices, though as predicted in this column last week Monday and Tuesday saw equity markets stutter giving short sellers a small window of opportunity mid-session to prosper before equities resumed their bullish run later in the week.

This decade has seen the rise of China’s economic profile, with the PRC now destined to replace Japan as the world’s second largest economy. Such is the dominance of Chinese related articles it’s easy to forget Japan is still an economic goliath, albeit in relative decline. And the cause of that decline can be summed up in one word; deflation.

There’s something deeply embedded in the Japanese economy and psyche of Japanese businesses and consumers that has caused deflation to be a secular and persistent challenge for the Bank of Japan for the past 20 years. The problem with deflation is that it maintains the real value and burden of debt, whereas a healthy rate of inflation, 2-3%, over the years gently erodes the real economic cost of borrowed capital. It is inflation that has given the western economies the luxury of consuming more in the present, with debt in nominal terms eroded by the passage of time. Deflation throws another spanner in the works of economic growth. Why buy a new car, or new machinery, in fact why buy anything today that will be cheaper in a few months? The result is structurally weak demand, an interest rate so low it’s barely visible to the naked eye and a flight of capital to higher yielding currencies (the New Zealand and Australian dollars have been a favoured destination for retail and institutional investors for years). Deflation is a nasty poke in the eye for demand, capital investment and growth.

In fact Japanese interest rates have been so low for so long, the Yen has been systematically sold (shorted) not just by Japanese investors but by a legion of hedge fund managers for years with the proceeds placed just about anywhere that offered a higher return. Admittedly that carry-trade, along with most risk embracing investment strategies, grew to bubble proportions and burst in 2008 but with investors embracing risk again, greed replacing fear, that transaction (short Yen, long anything else that moves) is likely to re-surface.

Investors unsure about the viability of continued Japanese deflation, preferring to focus on the unprecedented global stimulus measures, that should be inflationary, should look closely at the latest Japanese consumer prices data. Prices fell 1.7% in the year to June, prolonging the sequence of deflationary months (year-on-year) to four in row. The main contributor to the decline in prices is energy, with oil settling into $60-$70 channel compared to last years roller-coaster ride to $147.

Investors could suggest that the global economic recovery could re-inflate energy and commodity prices, prompting inflation and thus curing the Japanese “I’ll buy it later when it’s cheaper” philosophy. Unfortunately, higher energy costs are paramount to poking the Japanese economy in the other eye. Japanese energy imports can peak to 97% of its oil and 96% of its gas needs. Japan is similarly deficient in other key energy and mineral related commodities. Higher energy and commodity prices just leave Japanese consumers with less to spend on domestic goods, further hurting demand.

AUO to 30th Jan 09

The essence of Pawlewski’s system is that it is able to distinguish between appreciating stocks that are experiencing a short term pull back but will imminently rally and stocks that are falling and will continue to do so with near uninterrupted momentum. Using statistical analysis Pawlewski’s system can identify long trade candidates, which he would typically hold for an average of 10 days. Similarly, by using ‘reverse’ statistical analysis the system proposes short positions. The exact details of the process are confidential, but it is clear that Pawlewski can identify the ‘genetic’ code within a stock’s chart which under analysis by the Pawlewski system provides information regarding the future direction and pace of a stock’s movement.

Surprisingly, considering the rally, there has been an absense of good economic news on the day with the latest jobless claims data coming in slightly worse than expected.

QQQQ to mid session 30th July 2009

But the two, democracy and business, co-exist uncomfortably as there is a finite amount of wealth in the economy and that wealth needs to be shared equitably between two of the three participants in any economy: individuals, (workers, consumers and taxpayers) and businesses. The third participant is the government which should not pursue wealth or power for its own benefit but should act as the moderator and facilitator creating a scenario which allows the two other parties to prosper fairly, in correct proportion and in line with the law. To achieve this fair scenario key governmental decision makers should not have personal interests more aligned with one group, business, than the other, society.

In periods of economic growth when both the individual and corporations as a whole prosper the division of wealth between the two is naturally a concern. But those concerns are magnified significantly when the economic pool of wealth is contracting. In a recession tensions between the individual (the ‘man on the street’) and companies increase as corporations lay off staff to protect the interests of the firm’s owners. Tensions rise further when certain companies or industries receiving preferential treatment at the expense of industries with less political influence or the collective society.

The onus is on the government to ensure fair allocation of stimulus and support so that both individuals and companies exit the recession together, as far as that is possible. But if the country is still struggling to recover, unemployment is rising and the average individual is still suffering whilst certain corporations are already, again, enjoying abnormal profits then the division of wealth and the legislation that created that scenario is flawed. Also, corporate earnings can only grow quicker than GDP growth if the finite wealth of society is being re-allocated from the individual to corporations.

The past 25 years has seen the economic balance of power shift too far from the fair equilibrium. The few are benefiting at the expense of the many. Goldman Sachs is a beneficiary. Wall Street as a whole is another beneficiary. Main St has suffered. But the individual, the workers, the micro-engines of the economy have suffered most. Unfortunately, one dollar one vote is more popular than ever in Washington.

GS to 29th July 2009

Now, as the country continues its efforts to formally exit the worst financial crisis in living memory the enigma that is Banco Santander is better appreciated.

But in all logic the bank should be suffering a maelstrom of problems. Santander is domiciled in Spain, arguably the most vulnerable economy in Western Europe. The group also, in 2004, acquired one of the largest British banks, Abbey National, and it would be fair to expect Abbey to have a similar depth of exposure to struggling UK consumers and the housing market as the much maligned Northern Rock, RBOS, HBOS or LloydsTSB do, (the latter two now forming Lloyds Group). But Santander isn’t in a mess, nor was it on the verge of collapse like so many banks late in 2008. It didn’t dominate the headlines with news of government bail-outs or queues of panicking savers urgently trying to extract their cash. Quietly, professionally and with minimum fuss the Spanish bank has consolidated it position, strengthened its brand in the eyes of risk-averse consumers and built a reputation amongst banking sector observers for financial integrity and stability that most other Western banks can only dream of.

Santander’s strategy of geographical diversification and a commitment to building a relatively prudent book of loans and mortgages has protected its balance sheet from the worst excesses of the debt bubble, though obviously some additional bad debt provision has been necessary. The bank should be congratulated for having paid close attention to the Good Risk Management textbook, the book HBOS management left on the shelf, collecting dust, thinking it was a secret Martian code too complex to be deciphered.

Reviewing the financials from the latest quarterly report also reassures. The group’s attributable profit in Q2 has progressed to Euro 2,423m from Euro 2,096 in the prior quarter, whilst year on year performance is a modest 4% lower. The UK contributed 16% of profits, Latin America 34% and Continental Europe 50%. H1 2009 loan provisions rose 61% to Euro 4,626 from Euro 2,880 in H1 2008 causing a 19% descent in earnings per share which otherwise would have made strong progress. A proportion of the bad debt provision maybe ‘returned’ to the P&L if actual bad debts are less than the provision. Of course it is also possible that the provision is inadequate but with a diversified business model and exposure to the relatively healthy Latin America region, the future remains brighter for Banco Santander than many of its competitors.

The chart below highlights the growth in the bank’s NYSE listed ADR (Banco Santander Cent Hisp) which is deep in over-bought territory with a 14-day RSI of 77.38, so investors should add the firm to their watch list and reconsider the question of buying if better value returns.

Banco Santander STD to 29th July 2009

TIE as at 28th July 2009

The essence of Pawlewski’s system is that it is able to distinguish between appreciating stocks that are experiencing a short term pull back but will imminently rally and stocks that are falling and will continue to do so with near uninterrupted momentum. Using statistical analysis Pawlewski’s system can identify long trade candidates, which he would typically hold for an average of 10 days. Similarly, by using ‘reverse’ statistical analysis the system proposes short positions. The exact details of the process are confidential, but it is clear that Pawlewski can identify the ‘genetic’ code within a stock’s chart which under analysis by the Pawlewski system provides information regarding the future direction and pace of a stock’s movement.