Investment guru Burton Malkiel, author of A Random Walk Down Wall Street, has revealed at a briefing that Chinese equities form the largest part of his personal satellite portfolio, although the core remains in low-cost index funds.

Malkiel, in town to beat the drum for Vanguard’s index funds, argued that China will be the biggest economy in the world in 20 years’ time, but most investors are underweight the emerging giant. “I’m a real expert on China - I’ve been there five times,” he joked, but made the serious point that most investors have a home bias.

“In general, people are inadequately diversified,” he said. “When people ask me how much international diversification they should have, I say: A lot more!” He conceded that asset class diversification had not been much help last year when markets collapsed in a great unwinding, but added that gold and US Treasuries had provided some relief.

Malkiel believes investors would do much better if they didn’t try to time the market - because they invariably get it wrong.

Over 15 years, between 1994 and 2008, those who stayed the course enjoyed an average annual return of 6.5 percent, whilst those who missed the best 30 days were down 3.7 percent per annum. If you stayed out longer and missed the best 90 days, you’d be down 14.6 percent per annum on average.

Similarly, those investors who save regularly, putting money into markets every month through good times and bad, benefit from dollar cost averaging, essentially buying more units for the same monthly sum when prices have fallen, and then enjoying any subsequent appreciation.

It’s a victory for the tortoise, not the hare.

Five things to think about this week:

HOLDING UP — FOR NOW 
- A good run in equities has so far been helped rather than hindered by U.S. company results. Some are questioning how long the upward momentum can be sustained given cost-cutting rather than improved revenue streams flattered profit margins. The European earnings season, which cranks up a gear this week, and the release of U.S. Q2 GDP data could be potential triggers for a pullback, but the sensitivity to bad news may depend on how much money is chasing the latest push higher. 
    

EARNINGS 
- European earnings flooding out in the coming weeks may paint a less rosy picture of the banking sector than seen on the other side of the Atlantic. While investment and trading activities should be supportive, bad loan provisions will be particularly closely scrutinised, as will the central and eastern Europe exposure of the likes of Erste. The supply/demand outlook for key commodities plans will also be in the limelight given the battery of oil and chemical firms reporting in Europe and the U.S. 

CORRELATIONS 
- There are signs of some breakdown in the lockstep moves that financial markets had become accustomed to seeing in FX/stocks or stocks/bonds. Calyon research shows correlation between the bank’s proprietary risk aversion barometer and exchange rates has been less robust in the past month. While this correlation nevertheless remains stronger than that between FX and interest rate differentials, the markets’ thoughts are turning to new linkages that might prove better trading guides. 

RESISTING CARRY TRADES 
- The interest in carry trades has grown as investors have become more willing to venture out of the most liquid markets in the quest for returns but the subsequent appreciation in currencies such as the Australian and New Zealand dollar is provoking a push back from the central banks concerned. This suggests that others could be, or have been, tempted by tactics deployed by the Swiss National Bank, whose latest reserves data shows how actively it has sought to keep the Swiss franc in check. Australian reserve data suggest the Reserve Bank of Australia is already taking a leaf out of the SNB’s books, which will keep the market on toes in the coming weeks, while the Reserve Bank of New Zealand meeting this week will offer another chance for central bank rhetoric to counter the prevailing market trend. 

U.S-CHINA TALKS 
- FX reserves, U.S. and Chinese foreign exchange policy, who should do what to correct global imbalances, and trade issues will be on traders’ minds as the U.S.-China Strategic and Economic Dialogue kicks off early in the week. Chinese officials will be keen to avoid sending any signals that would jeopardise the value of the U.S. holdings in their $2 trillion-plus reserves but markets are alert for clues on how Beijing plans to play its medium-term drive for a multi-polar reserve universe.

Is Beijing trying to get its hands on the secret brewing recipe for Guinness?

China's sovereign wealth fund has bought a 1.1 percent stake -- worth around 240 million pounds -- in drinks group Diageo, which owns the legendary Irish stout.

China isn't yet among the top five markets for Guinness -- although Johnnie Walker whisky is apparently a favourite -- but the stout does already feature among Diageo's top brands in South East Asia and Japan.

Officials at China Investment Corp (CIC) probably felt like a stiff drink or a long pint of Guinness after the roasting the fund got for the performance of its investments in Blackstone and Morgan Stanley.

And while its investment in Diageo won't buy CIC the secret to the Guinness recipe, it should guarantee its officials a warm welcome when they visit the historic plant in Dublin.

Five things to think about this week

TUSSLE FOR DIRECTION
- The tussle between bullish and bearish inclinations — with bears gaining a bit of ground so far this month — is being played out over both earnings and economic data. Alcoa got the U.S. earnings season off to a good start but a heavier results week lies ahead and could toss some banana skins into the market’s path. Key financials, technology bellwethers (IBM, Google, Intel), as well as big names like GE, Nokia, Johnson and Johnson will offer more food for thought for those looking past the simple defensive versus cyclical split to choices between early cylicals, such as consumer discretionaries, and late cyclicals, such as industrials, based on the short-term earnings momentum. Macroeconomic data will need to confirm the picture painted by last week’s unexpectedly German strong orders and production figures to give bulls the upper hand.

FINANCIAL FOCUS
- The heavy financial results slate (Goldman, JP Morgan, Bank of America, Citi) will show the extent to which balance sheets are being cleansed of toxic assets and the health of, and outlook for margins, trading revenues, etc. The relative performance of the firms reporting could put the spotlight on the split between investment banking and retail exposure. In Europe, Swedbank’s results will be watched for Baltic exposure while clarity is still being sought on what banks plan to do with the large chunk of ECB one-year money which they continue to park back at the ECB in the form of overnight deposits.

JAPANESE DILEMMA
- The BOJ’s policy meeting poses thorny questions on quantitative easing (QE), with the policy debate complicated by sharp gains in the yen. The yen has risen as much as 10.5 percent in three months against the dollar and is nearing the 90 threshold which is viewed by the foreign exchanges as the point at which the Japanese authorities start ratcheting up the rhetoric. Further sustained yen gains will fuel market debate about the fallout for carry trades and for exporters — and by extension economic activity.

HOOKED ON QE
- The sharp jump in yields in gilts, euro zone debt, and Treasuries seen after the Bank of England deferred any decision on expanding its QE programme gave a good indication of how bond markets could react when central banks flag that the QE taps will finally be turned off for good. Implementation of exit strategies may be some way off and producer and consumer price data from both sides of the Atlantic this week are likely to be subdued. However, base effects from the oil price peaks of 2008 are expected to fade in the coming months, leaving a less supportive inflation backdrop.

CHINA
- The FX reserve debate was aired by the highest-ranking Chinese politician to date at L’Aquila summit and U.S. TICs data this week should keep the reserve holdings issue on the boil. Attention is also on Chinese domestic/trade policy following violence in Xinjiang and strains in relations with Australia over Rio Tinto staff detention. Any escalation in either could prompt investors to review the potential for regional outperformance.

Chinese anger at Rio Tinto for reneging on a deal with aluminium group Chinalco and opting instead for an iron ore joint venture with BHP Billiton last month was understandable. Indeed, China has good reason to question the Rio-BHP JV on competition grounds.

But the detention of four Rio Tinto employees -- on suspicion of espionage according to Australia's foreign minister -- bang in the middle of sensitive negotiations on iron ore exports to China is a
dangerous step in the wrong direction. Beijing must either justify the arrests publicly or release the Rio staff immediately.

Rio is locked in tough negotiations with China's massive steel sector following its refusal to agree to Chinese demands for a bigger cut in contract prices. As a result, Rio is for now at least charging its Chinese customers spot market prices, which are considerably higher.

Comments earlier this week by a Rio Tinto spokesman saying the company has never been so busy and is selling all the iron ore it can make can't have pleased its customers or the government in Beijing.

There is a history of bad relations between the two big iron ore producers and China's government. In the past this has prompted the miners to wrap themselves in the Australian flag to draw Canberra in on their side to protect their interests.

That last open confrontation came in 2006, when Canberra protested vigorously about a secret letter from China's Ministry of Commerce to the country's customs inspectors urging them to pay particular attention to the paperwork accompanying imports of Australian ore to ensure the ore matched the documentation precisely and reject any cargoes that did not.

Canberra threatened to refer the discriminatory treatment of Australian ore exports to the World Trade Organisation. The situation was defused following negotiations between Canberra and Beijing that resolved the "misunderstanding".

This is not the first time that China has charged foreign companies for espionage. In 1996, the authorities arrested a Chinese manager at Shell and one of her counterparts at the
China National Offshore Oil Corp. (CNOOC), charging them for stealing state secrets regarding plans by Royal Dutch Shell to build an oil refinery in southern China.

The secrets, according to media reports, involved information on the financing and environmental implications of the project. CNOOC was to become Shell's partner at the venture.

Foreign oil companies have believed that the arrests reflected concern about Chinese nationals working for foreign firms and using their local knowledge to violate the law.

Australia has rightly pushed China for an explanation of why the four Rio staff, who are part of its iron ore sales team, have been held. The four include one Australian national who is apparently accused of stealing state secrets, while the other three employees are reported to be Chinese citizens.

It's clear Rio is already in Beijing's bad books. But the company's "perfidy" -- Chinese news agency Xinhua's description of Rio's u-turn on the Chinalco deal -- is part of the cut and thrust of business. Deals don't always work out and in the case of Rio-Chinalco the decision to scrap it was in the best interests of the Anglo-Australian miner's shareholders.

Chinese hunger for natural resources -- particularly oil and iron ore -- is taking it to all four corners of the world to secure supply, often by buying assets or the companies that control them. Sinopec's recent agreement to buy Addax Petroleum and CNPC's renewed negotiations to acquire Repsol's Argentine asset YPF indicate Beijing has finally overcome previous resistance to its overseas expansion plans.

The quid pro quo for accepting investments by state-sponsored Chinese companies in raw materials abroad is an understanding that companies wanting to operate in China can do
so without fear of retribution if business deals do not go Beijing's way.

There is no place for detaining salesmen during negotiations on commodity prices, which smacks of bullying tactics. If there is real evidence of espionage or stealing state secrets, then Beijing needs to produce concrete evidence and fast. Failure to do so will stick in the throat.

It is in China's long-term interest to prove to the rest of the world that it can compete while playing by the rules.

Five things to think about this week:

REBOUND
- The global stock market has lost some of its spring, although it still managed a seventh straight  week of gains last week. A serious pullback has yet to be seen and the VIX is managing to hold fairly close to the sub-40 lows. Faced with a deluge of earnings, investors are picking their way through a mass of mixed earnings news and forecasts and displaying a more symmetric reaction to good/bad news than in past months.

STRESSES
- The U.S. financial stress testing timeline will put the focus back on the health of financials. Results, which are expected to point out banks’ varying ability to cope with a severe recession, are due out on May 4 and the financial industry is already flagging the risks of failing to spell out what would happen to the weaker links in the chain. Stress test results and any rumours or leaks before publication could prompt volatility.

DATA FLOW
- The release of advance Q1 U.S. GDP will offer investors a clearer sense of whether worst is in the past and could point way to what might feed any eventual “green shoots” of recovery. In the euro zone, national and regional sentiment indicators will point the way to firms’ and consumers’ mood at the start of Q2.

MONETARY POLICY
- Central bank meetings will be held in the U.S., Japan, and New Zealand. RBNZ is the only one of three with room to cut rates and there is some speculation that a more aggressive gesture could be on the cards to rein in markets, which are pricing in New Zealand rate hikes for next year. With the ECB due to outline any “unconventional” policy steps it might take on May 7, investors will scrutinise ECB officials’ comments for insight on what the consensus is building around.

FISCAL SPILLOVERS
- Fiscal stimulus in China looks to be filtering through to the real economy rather faster than in the developed world, prompting banks to upgrading China growth forecasts and investors to assess whether there will be a knock-on beneficial effect for commodity-producing emerging markets, which had suffered disproportionately due to the slump in global demand. Such a spillover effect is expected to especially benefit the Russian and Brazilian markets which have already rebounded.

(Reuter photo: Fayaz Kabli)

Top Chinese officials were busy showing off warships and submarines to celebrate the 60-year anniversary of their navy today, but they have something to boast about when it comes to their economy too.  It is, after all,  the world’s third largest.

China’s economy grew 6.1 percent in the first quarter, lower than expected but still far outpacing its G20 peers, many of which are stuck in recession.

Goldman Sachs has just upgraded its forecast for China, expecting 8.3% growth in 2009 (up from 6%) and 10.9% (from 9%).

“The stimulus is clearly impacting growth more substantially so far this year, but domestic demand has also responded earlier and more forcefully than we originally expected,” the U.S. bank notes.

“We expect both dynamics to carry into next year, with policymakers signalling more clearly that they are likely to keep policy aggressively supportive for some time and we expect private investment to pick up from government spending as we head towards next year.”

The Russell Greater China Index, which includes equity markets in Taiwan, Hong Kong and China, shows a 12.3% month-to-date gain through April 21 with materials, health care, producer durables being the top performing sectors.

ING says China’s proactive stance on monetary and fiscal measures has resulted in a significant rebound in loan and money supply growth.

ING’s Greater China equity strategy fund returned 3.9% in the past three months, outpacing MSCI All-Country Golden Dragon Index which gained 2.95%.

It’s not often that economists turn their attention to military hardware, but Deutsche Bank has done just that in its latest world outlook. The subject is aircraft carriers and what it sees as the strange desire among a number of countries to build them.

Russia has suggested it may build up to six carriers, DB notes, while China plans one and Britain and France three between them. Like the true economists they are, DB first questions the need, saying such boats are vulnerable, make no sense for coastal defence and are for projecting offensive power over long distances. Then comes the cost:
  

“To build a serious aircraft carrier costs well above $5 billion. But then you need to build half a dozen escort vessels and the aircraft to produce a battle unit that will require upwards of 10,000 sailors. Since it is for distant power projection, to keep a single aircraft carrier group on constant deployment requires at least two and more likely three groups.”

It reckons China can afford this because it only plans to build one. But Russia, even with a recent surge in wealth, is unlikely to launch a programme soon, it concludes.

Pakistan has agreed with the International Monetary Fund (IMF) on a $7.6 billion emergency loan to stave off a balance of payments crisis. 

Shaukat Tarin, economic adviser to the prime minister, said the IMF had endorsed Pakistan's own strategy to bring about structural adjustments. The agreement is expected to encourage other potential donors, who are gathering in Abu Dhabi on Monday for a "Friends of Pakistan" conference.

The government had long delayed announcing its plans to turn to the IMF for help and President Asif Ali Zardari said in September the country did not want to seek IMF assistance. Tarin said in October that going to the IMF was "Plan C" if other lenders failed to come through.  "If we want to go to the IMF, we can ... but only as a backup," he said.

The times are clearly changing and in the midst of a financial crisis that has swept away some of the world's most august financial institutions, there is no shame in admitting a need for help.

For that matter, I can remember former IMF Managing Director Michel Camdessus declaring confidently at one of the annual IMF meetings I covered in Washington in the mid 1990s that Keynsianism was dead. I challenged him at the time over his certainty, but wish I could ask the same question now that western economies are spending their way out of trouble like there's no tomorrow.

But what will it mean for Pakistan that its new government, less than a year after elections that ushered in a new civilian democracy, has had to eat its words and turn to the IMF for help?

Does it bring to Pakistan the silver lining that it offered India, which when forced to accept an IMF bailout in the early 1990s began a programme of economic reforms?  As noted in an earlier post,  India as a result began dismantling decades of licence raj and never really looked back. 

And why did Pakistan's closest allies, including the United States, Saudi Arabia and China, let it down by leaving it to turn to the IMF for help? As discussed in an earlier post, China, with $2 trillion in foreign exchange reserves, was in a strong position to step in to head off what could turn into a deeply unpopular move.  Traditionally seen by Pakistan as its most reliable friend, China appears to have decided that an IMF programme was the best medicine.

A new beginning? Or another source of instability?

Every month, Merrill Lynch asks a few hundred fund managers around the world what they think of the state of things. Not surprisingly, this month’s survey is probably the gloomiest yet. Everyone, says Gary Baker, the strategist charged with explaining the poll, is a macro bear suffering from hyper risk-aversion.

Of particular note for readers of Macroscope this time is the finding that 84 percent of fund managers, more than four in five, say it is likely that the global economy will experience recession over the next 12 months. It is actually possible that the figure is greater than that, given the question’s definition of recession as two quarters of negative real GDP growth. That definition is fine for countries, but for the global economy it is a bit nebulous.

At least one should hope so. According to the International Monetary Fund, global GDP should end up having grown 3.9 percent at the end of this year and drop to 3.0 percent in 2009. Blistering growth in places like China may cool, but is still likely to keep the world economy in growth. So many fund managers may have been considering a less specific definition of global recession. The IMF informally used to think of it as below 3 percent growth, for example, but is not so keen on this now.

Whatever the definition, Merrill’s fund managers are pretty clear about one thing - the times have changed. Each month, their thoughts on where we are in the economic cycle are plotted on a kind of clock, where 12 is mid-cycle and 6 is recession. Until January this year, they spent 3-1/2 years between 1 o’clock and 2 o’clock — essentially saying the economy was just past mid-cycle. The clock has ticked rapidly since January and is now at half past five.

All this begs a number of questions. 1) Are the fund managers right about recession, or are they just overreacting to massive losses on stocks markets? 2) Can Chinese growth continue to shore up the world’s? 3) If we are at 5:30, how long before the clock ticks to 6:35 and enters a new upward economic cycle?