Saturday, January 16, 2016

Decoupling Theory: Is it still valid?

Below you can find a text of a paper that I produced in 2009 on the topic of decoupling. I am posting it here, as I consider it to be valid today as it was then. When I wrote it, we were in the midst of a full blown recession and many things were unclear.

         After the first symptoms of recession of US financial markets, many investing firms and funds have changed their focus to emerging markets of Europe and Asia, specifically to China and India. One of the avid supporters of “decoupling theory”,  the president of Euro Pacific Capital, Peter Chiff, has confessed in his video blog on August 24’ 2009: “If you look at the big economies such China and India, they never even went into recession, they slowed down a bit, but now they are expanding even more strongly; they avoided recession. Some of the larger more advanced economies in Europe and other parts of the world, dipped into recession but now they are already out of the recession. It is the United States that is still in a recession. And initially, based on 2008, everybody thought - oh, no! When US catch a cold, the world gets pneumonia! Well, that did not happen. Everybody was afraid that was going to happen in 2008. That’s why US dollar rose; that’s why foreign stocks sold off more that US stocks. Everybody was waiting the world will catch pneumonia; they did not. They caught cold just like us; they did not even get as bad as we did. So what’s happening is global markets are recovering, global economies are recovering, and I think what we are having is “decoupling”, because I do not believe that US economy is recovering”.
  Decoupling theory is postulated in this context for assisting the firms to reap from these emerging markets, but the validity of this theory is arguable and has been a topic for discussions in numerous TV-shows, conferences and live events.
         What is “decoupling”? Decoupling theory, as the name suggests, decouple emerging world markets from developed countries’ markets (particularly US markets). The followers of this theory believe that “because of the strong GDP growth of many developing countries, especially of China and India, their markets will remain bullish even at the time US and other developed markets are in a recession.” The theory was pretty logical and right till the end of last year (2008), but things have changed considerably during this year as well. Most of the Asian markets are now in a big recession after the crash of Dow Jones, in March of 2009. On the other hand, Indian, Chinese and Hong Kong markets fell considerably in the last year or so.
         The major drawback of “decoupling” theory is that, it has not considered the multiple economic relationships and globalization trends. Although the trades among Asian countries has grown tremendously, the major trading partner for all of major Asian countries is still United States and any recession in its economy will lead to recession in all of these countries. Simple explanation for that would be the degree of interconnectedness among these same countries. One of the major contributors for the growth of any country’s GDP is a trade between one country and another. So, trade has grown considerably in the last couple of decades between so-called developing nations and developed nations, though the effect may vary from country to country, according to the diversification of economies of participating countries.
         The “decoupling theory” is widely accepted as a valid thesis in many business and academic circles. It is also considered to be an explanation for asset allocation practices in numerous investment management companies. No one knows exact amount of money that has been lost by investors who built their models on unproven strategies that work only in theory but fails in practice, such as ‘decoupling’, but the amount is known to be significant. As trillions of dollars were wiped off the value of global stocks last year, meanwhile "decoupling" became the latest big idea to shrink dramatically when tested in the real world with real consequences.
  Decoupling theory claims that European and Asian economies are not correlated or became less correlated, especially emerging countries’ economies have broadened and deepened to the point that they no longer depend on the United States economy for growth, leaving them insulated from severe catastrophic events, such as fully fledged recession or even a depression. Faith in the concept has generated strong outperformance for stocks outside the United States - until last year. As opinion began to solidify after the start of the year that a recession, or something close to it, was likely in the United States, stock prices then, a little later, the values for securities accelerated their declines on major stock exchanges, with the selling intensifying in the 3rd quarter of 2008. It was a clear sign of panic among investors. Contrary to what the decoupling theory enthusiasts would have expected, the losses were greater outside the United States, with the worst experienced in emerging markets and developed economies like Germany, Japan and France. Exports make up especially large portions of economic activity in those places, but that was not supposed to matter anymore in a decoupled world because domestic activity was thought to be so robust. Decoupling was all the rage early last year when international financial markets all but ignored the increasing turmoil in the U.S. Main news networks publicly ignored the severity of coming crisis. Bear Sterns sale to J.P. Morgan Chase though did make front pages of major newspapers. Previously, collapse of California based IndyMac Bancorp Inc. also failed to trigger an alarm for the economy. It was just assumed that these accidents do not jeopardize the economic power of US and investors still had optimistic projections about the economy. Investment advisers pointed out, however, that the segments of the U.S. economy that were showing wear and tear then were those to which the rest of the world would never be heavily exposed.
         That is no longer true, they say, and markets are responding accordingly. "Decoupling is yesterday's story," Stuart Schweitzer, a global strategist at JP Morgan, said. "Last year, when the U.S. slowdown was driven almost entirely by housing, it made sense that the rest of the world kept right on going. Housing is a domestic story, plain and simple.” The nature of the slowdown has changed in two key respects. The credit crunch or/and shortage of credits that began in midsummer of 2008 is not just a U.S. phenomenon; the rise in risk aversion is global and will have an impact on credit terms and availability everywhere. And we finally saw evidence that the U.S. job market was losing steam and consumer spending is slowing.
         True believers in decoupling have ignored another theory that appears to be logically inconsistent with it, but has been popular for far longer and, most important, which has been shown to work in real life. Remember “globalization”? "If anything, global interdependence of economies is rising, not falling, with even more coupled economic and financial infrastructure" said Jeff Applegate, chief investment officer of Citi Global Wealth Management, in his Wall Street Journal interview. The notion that the U.S. can go into recession with no negative knock-on effect in the rest of the world doesn't hold up anymore. On the other hand, Andrew Foster, head of equity research for Matthews International Capital, a specialist in Asian markets, contends in his blog, that “it is possible for globalization and decoupling to coexist. In fact, one gave rise to the other”, he said. It was only through economic liberalization which comes through globalization that the juggernaut economies of Asia were able to grow as fast as they have, allowing for the development of conspicuously consuming middle classes. The irony is that these economies are more coupled and connected with the rest of the world than they ever were in the past, that's why they're so strong, and that has allowed them to become more independent. The new Asian consumers may not be able to compensate for all of the exports that would be lost during an American recession, but some of the companies that served their needs might still do all right for themselves. The true decoupling may be not so much between the United States and the rest of the world as between segments of the global economy that cater to the burgeoning new rich class in emerging economies on one hand and most other commercial sectors on the other.
         With the United States apparently tipping over into recession, many investment gurus are looking to fill their Asia portfolios with the first type of businesses, as long as they have not been bid up to unreasonable levels already. A couple of pockets of opportunity that they find are Chinese insurance companies and Indian health care providers. Many American corporate behemoths such as Pfizer, goes for hunting as well. In October 29th, Pfizer announced its plan to go ahead and acquire Indian “Wockhardt Pharmaceutical Company”, which was met with optimism in markets of both countries. The case here might be to invest in companies that don't derive their fortunes from products, services and especially commodities dominated by the global business cycle. Valuation is also critical for many investment professionals such as Michael Avery, chief investment officer of Waddell & Reed and a professed believer in decoupling - up to a point. He noted that the concept began to pop into the heads of professional investors, including his, during the last U.S. recession, in 2001-2002, although it had not yet achieved buzzword status.
  Many investors started thinking and strategizing about where the world was going to head in a post-9/11 environment. The U.S. economy had slowed dramatically in 2001, and there were places in the world like China and India that continued to grow at mid to high single digits. That set in motion the thinking that the U.S. might not be the leading economic force going forward. While some investors accept the basic idea of economic decoupling, they are not fanatical about it as an investment theme, at least not now. The emerging world will grow faster than the United States, but they doubt that sufficient growth can be achieved to justify the valuations being put on companies in those markets by the new wave of decoupling adherents. For instance, average P/E ratio for a Chinese blue-chip company is now in ranges of 25-35, which gives signals of coming huge asset bubble and price bubble in public markets.
         The big difference of 2002 events is that not many people placed bets on that outcome, so there wasn't much risk. Now if we go anywhere, and talk about China and India and the emerging middle class, people will agree that it's a huge difference from five years ago. One can still find value in some of the domestically oriented sectors in Asia, as well as in Middle Eastern markets that continue to benefit from one key export, crude oil. We can safely conclude that the growth of middle-class spending is promoting a healthy expansion of trade within the emerging world. Some people believe that China is rapidly moving from being dependent on exports to the U.S. to enjoying a virtuous circle of rapidly rising incomes for Chinese consumers and very strong momentum behind internally driven growth. The proof for this hypothesis is that Chinese government spent around $584 billion, as fiscal stimulus for further infrastructure developments and facilitating Chinese middle class actively participate in economic growth.
  There is momentum in Chinese stock markets, too, but in a different direction. Perhaps the biggest beneficiary of decoupling is giving back much of its enormous gains of the last few years as investors break faith with the concept. Economic trouble has spread far beyond the United States to major countries in Europe and Asia, threatening businesses around the world with the loss of the international sales and investment that have become increasingly vital to their sustenance. Only a few months ago, some economists still offered hope that robust expansion could continue in much of the world even as the United States slowed. Foreign investment was expected to keep replenishing American banks still bleeding from their disastrous bets on real estate and to provide money for companies looking to expand. Foreign demand for American goods and services was supposed to continue compensating for waning demand in the United States. One thing is for sure, that US economy is dependent on other countries. The macro policies being implemented by foreign governments make it more complicated to predict the possible future for decoupling theory.  
  Investors are still in search for models which will give them the returns they desire with risk appropriation they can afford, but now we can state with less certainty that emerging markets are the place to go.

         What is the future course for economies of developed countries, emerging countries? What is the future trend for the financial markets?

         These questions are considered to be of utmost importance for anyone who has a little amount of interest in markets. Yet no sensible answer can be given under circumstances we are in now. Simply put, it is not knowable and not possible to predict. Future has never been certain, but one thing is clear that many more challenging times, busts and crises are ahead of us. However, the issue investors should be concerned about is the time frame when ‘confidence’ will return to markets. On the other hand, emerging countries should look for ways to bolster economies in the short term and work on making it sustainable on the longer term basis.
         With global stock markets plunging on fears of a US recession and the Federal Reserve cutting rates in the wake of their collapse, the theory that much of the world economy has 'decoupled' from the United States looks increasingly dubious.
         Decoupling was the latest of the periodic 'it's different this time' theories to sweep through the world's financial markets. The idea was that there is enough economic growth in and among emerging markets -- and perhaps even Europe -- that a US recession would not automatically drag down the rest of the global economy.
          Some experts expressed a bit extreme views such as, ‘the decoupling theory is lying in ruins’; others confided that they ‘never thought it was much of a theory anyway,’. Though the fact is that US is a quarter of the world (economy) and if its imports slow down, the rest of the world will slow down too. Here we see clear cause and effect relationship between US economy and its trade partner’s economies.
  It certainly ends the idea of 'pure decoupling'. The old saying was that if the US economy caught a cold, the rest of the world got the flu. It's clear that if the US gets the cold, there's no complete decoupling, the rest of the world's economies aren't immune from whatever ails the US -- or vice versa.
            Economists at Global Insight, for example, cut their 2008 global growth forecast to 3.4 pct for 2008, given 50/50 odds of a US recession. Markets reacted with 2.1% drop in one day, after the release of this prediction. Here we see markets’ sentiment towards, risk avoidance.
            There is a distinction to be made, however, between the world's actual economies and the world's financial markets. The financial linkages are much stronger than before. The financials are much more linked than the actual economy, in the sense that they are faster to process information.
            The unpredictable element of coupling in all of these forecasts is global investor psychology. It's being driven by sentiment and emotions than anything. In a state of panic and uncertainty, it's hard for the markets to decouple.
            The reality is clearly more complicated. Notable emerging markets will undoubtedly come out of the financial crisis with an ability to sustain significantly higher economic growth than its industrial counterparts. This ability reflects healthier financial conditions, greater policy flexibility through surpluses, and more dynamic sources of growth. However, it is clearly premature to consider emerging markets as independent sources of growth. The base effects are still low and a large portion of growth seen this year comes out of transitory and ultimately unsustainable means (massive stimulus in China, for example). For investors, reliable indicators that will signal a shift toward sustainable, independent growth in emerging markets will be domestic consumption levels and the extent to which policy recognizes and encourages the consumer rather than the producer. Specific policy measures would be a stronger social safety net (traditionally lacking in countries like China) and greater exchange rate flexibility.


1. Max Wolff. “Debunking the Decoupling Theory”, Seeking Alpha  (January 27’ 2008)
2. Conrad De Aenlle. “Decoupling vs. Reality”, The New York Times (February 7’ 2008)
3. Daniel Pipitone. “Decoupling Theory of Emerging Markets”, NobleTrading (January 22’2008)
4. Heather Bell. “Is Decoupling Done?”, Yahoo Finance (January 8’ 2009)
5. Gavin Jones. “Decoupling: What really happens when US sneezes?”, Reuters (Feb. 5’2008)

6. Pedro – Pablo Kuczynski. “Are the Emerging markets Decoupling from United States?”, International Economy (2005)

Connection Between Oil Prices and the State of the Economy - My Perspective

My philosophy is to stay market direction agnostic at all times. I do not pretend to have powers to forecast and predict the flow of future events. I think, it is hard to understand the current state of affairs in the complex system of markets that I just don't see any point in having to try to predict the future and then act upon my predictions.

My view is that, as a trader or an investor, I just have to try to position my trades so that I can benefit from both falling prices and rising prices. That's a fiduciary duty, so to speak to my family, my investors and myself. Trading is tough, and there is no time for complacency, and bitching about things that didn't (or don’t) work. So one has to stay alert at all times.

Now, let's come to the core point of my article. Lately, one of the hottest topics in the news, mainly in the business news, was the state of the economy around the world. The other topic, which is no less popular is the falling prices for energy sources, mainly oil (crude and WTI). So-called experts on TV, often mix aforementioned topics with each other, to conclude that low prices for energy sources directly linked with the weakness of economies around the world. I don't quite agree with this thesis.

Major reason for low prices of oil, is the absence of demand or/and excess of supply. This is the fundamental rule of economics. Next, let’s talk about demand.

Can we categorically state that low level of demand indicates weak economic stance? Might there be other, underlying reasons for oil prices to fall. In my view, we should talk about the nature of demand and explore possible reasons for falling price of oil.

Let's try to dissect the nature of demand:

China has traditionally been a huge consumer of oil. So the real question is why China has stopped consuming certain amount of oil. The answer might be that businesses started consuming less oil, or because they became more productive and more efficient in using oil as a raw material. The other reason might be that China has started to rely on its own production of oil. As we all know, one of the policy measure that Chinese government is trying to push is the use of own raw materials and stop relying on imports.

Historically, China has been deploying protectionist policies in other types of raw materials from to time. In 2011, Chinese regulatory agencies placed a ban on exporting rare earth metals, which led to a temporary distortion in the world markets. Many consumer electronics companies rely heavily in Chinese exports, so many had to adapt to new market rules. Therefore, it is safe to say, that Chinese are trying to become more self-sustainable in its use of energy sources.

We all know that there are exporters and importers of oil. Oil is being traded around the world, on major exchanges. The price of oil is actually a price of a futures contract for a barrel of oil, with an expiration or delivery date of 3 months out. Initially futures were meant to use by oil exporters and importers to hedge their risks, of low and high prices respectively. However, now the oil markets are open for everyone to speculate on. Nowadays, the oil traders (the specialized firms that help producers to sell their products) trade mainly oil (of various sorts) for physical delivery. The last point is very important, as it shows that a certain body or agency, or cartel is not setting oil prices. Players of the market set the prices. Supply and demand in the markets for oil regulates the prices for oil futures.

Then, a keen observer from the outside might ask: What are the motivations for players in the oil market to sell or buy the commodity? This is an excellent question. The answer to this question will partly give us a clearer picture of the nature of prices of oil.

Market participants react to various statistical data. From the supply side, it’s the amount of produced oil in various countries, that has major market shares. One example of such a country, or in this case organization is OPEC (cartel). Traditionally, the OPEC countries satisfies the supply side of oil for about 30-40% of the total amount of produced oil. The news might come that OPEC countries have increased their production. This news is bearish for oil prices in general, if the demand is staying the same from the countries that has tradionally been consuming majority of oil produced. One such country is China. China as a whole has been consuming majority of oil produced around the world. Therefore, in our example, if wee that supply from OPEC has increased while demand from China is staying the same, then we might deduce that market participants will push price for oil lower. In our real case, the supply side grew their production with a ever increasing speed, while demand side dropped. China has been consuming less and less oil. All the other economies that used to be buyers of oil, now has stopped their procurement.

The founder of IBM, Tom Watson Sr., once uttered this:  "I am no genius, I am smart in spots, but I stay around those spots". Similar to Tom Watson's thinking, I also try to stick around the areas that I consider myself more or less knowledgeable, and that is trading/investing. I am not an economist, but I have my own opinions. But, what makes me different, is that I use my judgments in my trading/investing activities, so if I am wrong I lose money, if I am right I make money. I personally take risk with my own money. Many talking heads on TV do not have any personal responsibilities, as they are just “talkers”, which is unfortunate.

Saturday, January 2, 2016

Today is the Day

"If you drill down on any success story, you always discover that luck was a huge part of it. You can't control luck, but you can move from a game with bad odds to one with better odds. You can make it easier for luck to find you. The most useful thing you can do is stay in the game. If your current  get-rich project fails, take what you learned and try something else. Keep repeating until something lucky happens. The universe has plenty of luck to go around; you just need to keep your hand raised until it's your turn. It helps to see failure as a road and not a wall."

Article in WSJ, by Scott Adams.

Recently, I was reading articles by Scott Adams and the part above reminded me that the principles he was laying, was applicable to a trading business.

He says, that we can't control luck, but we can control the game that we choose to play. It's important to play the game where luck might come to us. Let's think about real life application.

 Example: In trading, it's important to be verse in the nuances of the strategy that we use while trading. The details like the best time to trade, stocks that we trade are important. If we know the rules well and follow them 100%, then we literally make ourselves attractive to luck, so that we might find luck more often.

The concept of staying in the game is important too. Losing money is part of the game, but we always have to remember that we have to have tomorrow too. If we lose 100% of our capital, by risking it all, we lose the chance to fight back. We should never put ourselves in the position that we might lose everything. I admit that I made such stupid mistakes, but no more. After couple of hard drawdowns, I am tryin very hard to not let it happen again.

Failure, in trading the fact of losing money should be viewed from the right angle. Losing, as I said is natural to this business, to any business in my opinion. But, the important part is what we learn from it and how we change our behavior after losing money. Small mistakes, will happen, and it's crucial not to let small mistakes grow into big ones.

Friday, January 1, 2016

Trading Results

Its' been long time since I posted an article here. Mainly, as I was busy with various life projects. I have started a new job and I am trying to trade options and futures on a full time basis too.

One other reason, for being absent is that I didn't have many changes in my portfolio and was basically keeping various securities in my portfolio. However, in 2016 I will move to a more hands on strategy and will be trading options and futures on a  daily basis.

2015 Results and Recent News for 2016

 The following is the annual letter to my investors (mainly to my wife). Please enjoy.

January 2, 2016
Astana, Kazakhstan

Dear Partner,

In 2015, the Green Valley Fund (“GVF” or “Fund”) appreciated by +52.5% on a gross return basis. Since the inception of the “GVF” on March 1, 2014, the Fund has appreciated by +109% before LP related allocations.

2014 (from 03.01.14)
Since Inception (03.01.14)
GVF Gross Return
S&P 500

Fund Performance
The 2015 has been an interesting year in terms of asset allocation. There has definitely been difficulties. However, the result was up to par and we achieved our goal of 35% threshold.

Mainly the gains were achieved by having AAPL, AMZN, NFLX and GOOGL in the portfolio. The mentioned stocks were bought in the first part of the year and held through the year-end. No other stocks were bought.

Major News

In 2016,  I will change my strategy from passive holding of securities to a more active trading. Mainly, I will be trading options and futures. And after March, I am planning to start trading stocks too. I will be regularly posting my ideas, thoughts and results here, on my blog.

Best regards.
GP - Talgat Akhmetov
Tel: +7 (701) 218-8106
Date: January 02, 2016

Why Companues Go Public: Rationality Comes First

This is a post that was written as a response to the post on FB. Here is the link: