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Will Scotland Leave? Polls Say Maybe. Market Says No.

Thursday is the big day.  After the polls close, we’ll know if the United Kingdom remains united or if Scotland will be going it alone.  With just a few days to go, the race is a statistical dead heat.

Data from


Given that we’re talking about the potential breakup of a major banking and financial power, a founding member of NATO, a nuclear power, and a permanent member of the UN Security Council, you would expect the markets to be on edge.  Yet investors seem far more preoccupied with the Fed’s schedule for raising interest rates (deliberating the precise date of the Fed’s decision to raise rates by 25 basis points is as inane an argument as  how many angels can balance on the head of a pin, but that is another story for another day).

Yes, the British pound has fallen sharply against the dollar over the past two months (see chart).  But then, the euro has been selling off vis-à-vis the dollar as well, and in any event, the pound‘s declines still put it positive territory over the past year.  The dollar’s recent strength could just as easily be attributed to the expected tightening of Fed monetary policy.


How should we interpret this?

It would appear that the market is discounting a Scottish “No” vote (i.e. a decision to stay in the Union).

As a general rule, betting markets are more accurate than opinion polls in predicting political outcomes such as elections, which makes sense: people tend to take their answers a lot more seriously when money is on the line.  Apart from the action in the capital markets, betting sites would seem to confirm that the United Kingdom will prevail.  The odds of Scotland leaving are only about 22%, according to predictions market site Intrade.  And gambling site Betfair puts the odds of Scottish independence at about 5 to 1.

Still…what if, perhaps inspired by a Braveheart movie marathon, the Scots surprise everyone and do vote for independence.  What happens then?

MarketWatch’s Matthew Lynn argues that a “Scoxit” would be an economic non-event and the rest of the UK would be better off without Scotland, citing, among other things, Scotland’s older, sicker demographics , its higher public spending per capita, and its declining oil revenues.  A UK without Scotland would likely be more market friendly and more economically dynamic.

In principle, I would agree.   And in the long term—assuming the rump UK didn’t do something suicidal like exit the EU in 2017—Lynn is probably right.  But a lot can happen in the meantime.

Here are a few possibilities:

  • Scottish banks would flee Scotland en masse for London. The Royal Bank of Scotland (RBS) and Lloyds (LYG), which owns the Bank of Scotland, have both already indicated they would leave Scotland.  Any bank that didn’t leave would be at risk of having no viable guarantor to bail them out during the next crisis.  Certain “real economy” companies—think Scotch whisky maker Diageo (DEO)—would have a harder time rearranging their businesses.  But expect capital and business to move south of Hadrian’s Wall.
  • The uncertainty that comes with a “yes” votes spills over into Europe, further undermining Europe’s economic recovery as companies withhold new investment until the dust settles.
  • Investors panic that a UK split-up will give strength to separatists in Spain and Belgium, and we return to the “bad old days” of 2010-2012 when it appeared that Europe was coming apart at the seams.

So, what should we do if the Scots vote yes?   I would err on the side of caution by raising at least a little cash.  I don’t expect a Scottish yes vote, and even if we do get one I would expect the fallout to be relatively contained.  We may even get a nice buying opportunity in potential “contagion” markets like Spain.

My advice: Wait and see.  If the Scots vote to secede, we could have a nasty correction in European shares.  If this happens, use it as a buying opportunity to pick up shares of solid blue chips like Spain’s Banco Santander (SAN), BBVA (BBVA) and Telefonica (TEF)—all solid multinationals with a large chunk of their operations outside of Europe.  But wait for the dust to settle first.  I should emphasize that we really are in uncharted territory here.  We’ve seen plenty of countries disintegrate in recent decades, with the Soviet Union and Yugoslavia being the two biggest that come to mind.  But none has been as systemically important to the world financial system as the UK.

In the meantime…you might need to pour yourself a tumbler of scotch to ease any anxiety going into Thursday’s vote.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Japan: Apocalypse Now or Apocalypse Later?

Japan can’t do anything right.

That’s not a criticism, mind you, but rather an observation of how truly bad Japan’s options are right now.  If you want a “risk free” trade for the remainder of this decade, it would be this: short the yen.

Let’s dig into the ugly details, starting with fiscal policy.

If Japan is to have a viable future, it needs to drastically reduce its annual budget deficits and national debt load—which, at 227% of GDP, is more than double the indebtedness of the United States.  But any attempt to do so will take a wrecking ball to Japan’s fragile economy…and perversely cause the debt and deficit to expand rather than contract…thus pushing Japan closer to the edge.

Case in point: Japan raised its national sales tax in April from 5% to 8% in order to plug its budget deficit—which was a gargantuan 7.6% of GDP last year—and its economy contracts at an annualized rate of 7.1%.

Japan is at least tentatively planning to raise the sales tax again next year, from 8% to 10%, though Prime Minister Abe may have second thoughts if Japan’s consumers continue to sit on their wallets.

How bad is Japan’s situation here?  43% of the Japanese government’s current spending is financed by debt sales…and 23% of that goes to meeting the interest payments on the existing debt load.  And all of this is made possible by the low levels of Japanese bond yields. Japan’s 10-year bond yields a pitiful 0.58%; were Japan’s borrowing costs to rise to levels on par with those of the United States or Europe, debt service would completely overwhelm the budget. Even at current rates, if Japan were to literally cut all discretionary spending to zero, it would still run a budget deficit in order to pay its current interest and social security obligations.

So, Japan’s yields must, by necessity, stay low.  Which brings me to the Bank of Japan and monetary policy.

Ben Bernanke fired his proverbial big bazooka when he unleased QE Infinity: bond purchases by the Fed of $85 billion per month for as long as Bernanke and his successors felt it necessary.  (Current Fed Chair Janet Yellen will probably finish tapering Bernanke’s QE program next month.)

The Bank of Japan leaves the Fed in the shadows when it comes to quantitative easing.  The BoJ buys ¥7 trillion—or $65 billion—of Japanese government bonds every month. But by IMF estimates, The American economy is nearly three and half times bigger than the Japanese economy.  So, adjusting for the sizes of their respective economies, Japan’s QE program would be $222 billion in bond purchases per month

The Bank of Japan is the Japanese bond market now, and for all intents and purposes, the BoJ is directly financing the government.

If that is not enough, BoJ governor Haruhiko Kuroda promised “additional easing” earlier this week “should conditions emerge.”  Perhaps Mr. Kuroda plans to use BoJ funds to buy every Japanese adult a new Lexus.  Why not.  He’s tried everything else.

Meanwhile, Japanese investors are fleeing the island as fast as they can in search of higher yields and more stable currencies.  Outflows into foreign shares last month reached the highest levels since 2009.

Might it be possible for Japan, buoyed by a weaker yen, to simply grow out of its problems?  Abe styles himself as a market reformer, as Japan’s equivalent to Margaret Thatcher or Ronald Reagan.  Could the right mix of pro-growth reforms shake Japan out of its malaise and put it on proper footing?

Not a chance.  I addressed Abenomics’ “third arrow” of tax cuts and market reforms back in June, noting that, while cutting taxes is a fine idea, it’s not likely to do much for Japanese business investment.  Japan is already sitting on overcapacity and has some of the poorest returns on investment in the developed world.

But the biggest reason for my gloom towards Japan—and why I believe that no set of the “right” policies will help at this point—is Japan’s depressing demographic picture.  Japan is the oldest country in the world with a quarter of its population already over the age of 65. Japan’s population peaked seven years ago at 128 million and hasn’t stopped shrinking since — Japan has about a million fewer citizens every year. By 2060, the Japanese government estimates that Japan’s population will have shrunk to 87 million people, and as much as 40% will be older than 65.

At the risk of being morbid, Japan is running up debts today that no one will be around to pay in another few decades.  The yen’s recent decline to a six-year low against the dollar has been extreme though orderly. I don’t expect that to be the case for long.  When the bond and currency markets finally lose confidence in Japan, I expect to see a total collapse in the value of the yen.

My recommendation?  Buy the ProShares Ultra Short Yen (YCS) on any short-term rallies in the yen.

Be careful here; whenever the market goes into “risk off” mode and traders unwind their carry trades, the yen can enjoy massive short-term rallies.  This is precisely what happened during the 2008 meltdown.  So, be patient, and look for good entry points.  This is a long-term macro trend that may take years to fully play out.

This piece first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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How to Play Argentina’s Supreme Court Setback

You could write a morality play about Argentina’s debt woes.  A vengeful market has never forgiven the country’s original sin of debt default in 2002.  Argentina spent years running away from its debts, even running to the likes of the late Hugo Chavez for funding.   The country restructured about 93% of its bonds in 2005 and 2010, but a group of “holdouts” has pursued the remainder with the zeal that Inspector Javert pursued poor Jean Valjean, going so far as to force the impounding of an Argentine  navy ship in Ghana two years ago.

Not that I feel sorry for Argentina, of course.  The country got itself into this mess by borrowing too much money and then arrogantly refusing to pay it back.  Argentina has also pursued a range of disastrous anti-market policies over the past decade, has made a habit of expropriating foreign assets (as was the case when it effectively stole Repsol’s YPF (YPF) stake), and has even contributed to the soaring world price of beef by restricting exports in a boneheaded attempt to contain inflation.

But the U.S. Supreme Court decision on June 16 to let stand a lower court ruling that would require Argentina to make its holdout creditors whole or effectively be restricted from the global financial system is potentially bringing this morality play to an end.  Without some sort of deal, Argentina faces another default at the end of this month, as it lacks the cash to make the holdouts whole and pay its other bondholders.

NML Capital, the hedge fund leading the holdouts, said Thursday  it is ready to negotiate, and Argentina’s government indicated Wednesday that it was prepared to send representatives to New York.

Argentina seems to be in a deal-making mood these days.  Argentina settled its dispute with Repsol in April and settled with the “Paris Club” of sovereign lenders in May.  The hedge fund vultures are the last impediment to Argentina being a “normal” country again, or as normal as a country with Argentina’s history can ever hope to be.

I expect capital to start flowing back into Argentina this year, as a settlement will remove much of the uncertainty that has made investment all but impossible.

So, how do we play Argentina’s return to polite society?

One option is via the Global X FTSE Argentina 20 ETF (ARGT), a basic of liquid Argentine stocks.   ARGT is heavily weighted in international oil and gas pipeline maker Tenaris (TS) and in state oil company YPF (YPF), at 20% and 13% of the portfolio, respectively.

I’m ok with that.  I expect most of the investment flowing into the country to go straight to the energy sector.

Action to take: Buy ARGT and expect to hold for 12-18 months for 30%-75% gains.  Use a 15% trailing stop as risk management.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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How to Invest in a Bacon Bull Market

A bacon shortage?  Say it ain’t so.

Unfortunately for American bacon lovers—though no doubt fortunately for their health—a porcine virus is ravaging the U.S. pig population and will probably cause the biggest decline in pork production in more than 30 years.  Meanwhile, demand for pork—and bacon in particular—continues to rise; U.S. bacon sales increased last year by 10% to a whopping $4 billion.

The resulting supply squeeze has caused pork prices to already rise by about 10%. Bacon prices have been particularly affected—up about 13% year-over-year.

I’ve been known to eat my share of bacon. Were I ever a condemned man, I would request a large plate of bacon as my last meal, washed down by a decent single-malt scotch.  (Hey, let’s keep it a little classy here.)

It seems like bacon is everywhere these days.  It’s jumped off the breakfast menu at IHOP and into places and products that are surprising even a confirmed bacon lover like myself.  Bacon jam to put on your toast in the morning?  It exists.  There is an all-bacon restaurant in New York—Bar Bacon— and a Bacon of the Month Club (I am not a member…yet), and a poll by Smithfield Foods found that 65% of Americans were supportive of making bacon America’s “national food.”  Taking it to levels that only an addict could appreciate, Olympic gold medalist Sage Kotsenburg tweeted that he wished his medal was made of bacon. And the ultimate?  You can buy bacon condoms.  I couldn’t make this up if I wanted to.

A bacon shortage would be devastating to millions of grease-loving unhealthy American slobs like myself. But all joking aside, there are real economic consequences.

I’ll start with pork product stocks.    While there is no true substitute for bacon—absolutely none, and I consider turkey bacon an unholy abomination—the fact is that consumers will shift to other meats if they become significantly cheaper on a relative basis.  This means that pork processors cannot fully pass on the price hikes to consumers—and that their margins should be crimped as a result.  This isn’t particularly good news for Hormel (HRL) and Tyson Foods (TSN).

But the biggest impact of rising pork prices goes far beyond U.S. shores.  China is the world’s largest consumer of pork, eating six times as much pork as the United States.  Despite China’s vastly lower per capita income, Chinese diners eat considerably more pork per person than Americans.  Among large-population countries, only Germany, Italy, and Spain consumer more pork per capita than China—and China is close to surpassing Italy. Three fourths of all meat consumed in China is pork, and the Chinese government considers pork critical enough to have created a strategic pork reserve.  Yes, that’s a real thing.


So, a global shortage of pork—were the U.S. porcine virus to spread—would potentially wreak havoc on China’s major pork producers, such as Tianli Agritech (OINK) and WH Group—the Chinese company that bought Smithfield Foods last year. WH Group is planning an IPO in Hong Kong this year.

Rising pork prices also present the Chinese government with an unappealing set of choices.  Do they exhaust their strategic reserve and possibly start an expensive pork subsidy to keep their middle and working classes happy?  Or do they wait it out and hope that any price spikes are temporary? Food-price inflation could threaten China’s plan to reorganize its economy away from exports and investment and towards domestic consumption.

Chances are good that the price spike will be temporary and that, once the virus is contained, pork production will return to normal levels.  In the meantime, keep your eyes open for the WH Group IPO.  If you believe, as I do, that the rise of the Chinese middle class consumer is a durable and investable trend, then investing in the world’s largest pork producer is a fine way to play that trend.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Outlook for Gold in 2014

Gold had a rough 2013. With a loss of 28% on the year, the spot price of gold was down by nearly the same percentage that the S&P 500 was up.  And I don’t expect gold to regain its shimmer in 2014.

Let’s take a look at the macro environment as we enter the new year:

  • The inflation that gold enthusiasts have feared since the onset of the 2008 crisis is dead on arrival.  The latest CPI figures show an inflation rate of just 1.2%, and energy prices are actually falling.
  • The quantitative easing that fueled the inflation fears of the past few years is already being tapered, from $85 billion in bond purchases per month to $75 billion per month…with more tapering to come.
  • The Federal budget deficit, though still far too high, continues to fall and is expected to be just 3.3% of GDP in fiscal year 2014.
  • Gold miners are contemplating hedging their risk by selling their production forward,  which will effectively cap the price of gold (and sends a very negative signal to the market).
  • Hedge funds and other large institutional buyers—the driving force behind much of the rise in the spot price of gold in the past decade—appear to be abandoning gold if the outflows from gold ETFs are any indication.  Gold ETF holdings are now at their lowest levels since 2008.
  •  Gold now has competition in the anti-establishment crowd from Bitcoin and other “virtual” currencies.  (I think Bitcoin is a joke, mind you, but that doesn’t mean that it won’t continue to steal gold’s thunder for a while longer.)

And on top of all of this, we should remember that gold had a monster secular bull market run that lasted twelve years.  When the last bull market in gold broke, in 1980, it took two decades for it to finally find a bottom.

I try not to spend much time on specific price targets, as I see these as being something of a distraction but I expect the spot price of gold to finish in the range of $1,000 to $1,100.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends.

This article first appeared on InvestorPlace.

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