SNL: Obama's China Visit

It looks like SNL's writers have a much better command of economics than our policy makers.

America's middle class also deserves a wet kiss, an expensive dinner, and a double feature.





link to video

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

China: Government Planning At Its Worst

Nice work from Al Jazeera highlighting the lengths China has gone to in order to sustain its economic growth. China may have a very bright future, but investors ignore China's expensive stock market, urban real estate bubble, and manufactured economic statistics at their own peril.

The advantage to centralized decision-making is the speed with which decisions can be made. The downside is clear in the following video.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Quote Of The Day: Qin Xiao and Chinese Bubbles

This quote comes from a Financial Times story entitled, "Top China banker warns on asset bubbles." What I most appreciate is that I can't imagine a top U.S. banker saying this. From the article:

China needs an “urgent” tightening of monetary policy to prevent the huge stimulus measures introduced this year from inflating stock and property bubbles, one of the country’s leading bankers has warned.

Qin Xiao – chairman of China Merchants Bank, the country’s sixth-biggest – says in Thursday’s Financial Times that the government should not be afraid of a “moderate slowdown” in the economy.

“Monetary policy must not neglect asset-price movements,” he writes. “Therefore it is urgent that China shifts from a loose monetary policy stance to a neutral one.”

Of course, this doesn't mean that the authorities will be immediately changing policy (though they should). However, if they continue their loose monetary policy, their stock and real estate bubbles will get out of hand. The higher they run, the harder they'll fall. It'll be interesting to see how the authorities walk the fine line between encouraging employment growth and asset bubbles and intentionally (and responsibly) slowing economic activity. Regardless, the fact that a private sector leader can so freely, frankly, and intelligently speak his mind is refreshing, even if it's coming from half-way around the world.


Disclosure: We recently sold our China equity exposure.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Poking The Chinese Dragon

It is very widely agreed upon that the trade wars that began with the Smoot-Hawley Act of 1930 were a significant contributor to the severity of the Great Depression. Obama's advisers are well aware of this, but this didn't stop the President from deciding to impose punitive tariffs on tires imported from China, increasing the tax from 4% to 35%.

Considering the desire of virtually every U.S. business to sell to the Chinese, the likelihood that China will be a substantial positive contributor to global GDP in the coming decades, the fact that the Chinese hold a significant amount of U.S. Treasury securities, and the notion that Chinese funding of our future deficits would certainly be helpful, it is clear that this move is being done simply to appease Obama's union support.

It's hard to imagine the Chinese will be pleased by this move. We're bound to see some form of retaliation from them before long. Of course, our politicians will be outraged by any Chinese retaliation. Let's hope this gets nipped in the bud quickly and doesn't escalate.

Evidence that this is simply a political ploy rather than a sound economic decision made with the best interest of the country in mind comes from a New York Times piece on this subject.

The Tire Industry Association has opposed the tariffs, arguing that they will not preserve American jobs but will instead cause manufacturers to relocate plants to other countries where they can produce tires cheaply.

Also,

The decision signals the first time that the United States has invoked a special safeguard provision that was part of its agreement to support China’s entry into the World Trade Organization in 2001.

Under that safeguard provision, American companies or workers harmed by imports from China can ask the government for protection simply by demonstrating that American producers have suffered a “market disruption” or a “surge” in imports from China.

Unlike more traditional anti-dumping cases, the government does not need to determine that a country is competing unfairly or selling its products at less than their true cost.

So, we're not upset that the Chinese are dumping their product at less than cost to steal market share. Apparently, we're just upset that the Chinese are selling a competitive product at a price Americans find attractive. If that's the threshold for tariffs, why aren't we slapping tariffs on every product China makes?

In the short-term, Obama may have won points with his union supporters, but at what cost? We're likely accelerating the loss of these manufacturing jobs. We're risking a trade war with the next super power. And, despite falling income and soaring unemployment, every American will now have the patriotic opportunity to pay more for their tires. The treadwear on the American taxpayer continues to increase.

This post was put aside for a day. As I was getting ready to send this out, I saw the following story from Bloomberg:

China to Probe Alleged ‘Dumping’ of U.S. Products

Sept. 14 (Bloomberg) -- China announced a probe into the alleged dumping of American auto and chicken products, two days after U.S. President Barack Obama imposed tariffs on imports of tires from the Asian nation.

Chinese industries have complained that they’re being hurt by “unfair trade practices,” the nation’s Ministry of Commerce said on its Web site yesterday. The Beijing-based ministry is also looking into subsidies for the products, it said. It didn’t specify the imports’ value.

link to full story

It's hard to blame the Chinese for retaliating. We'd certainly do the same had they acted first. The Chinese are most likely to target a value of American imports fairly equal to the value of Chinese tires being impacted. If we know what's best, we'll leave it at that and go back to squabbling over North Korea.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

American vs. Chinese Bankruptcy

Hat tip to my friends over at Calculated Risk for bringing the following LA Times article to my attention, "Some owners deserting factories in china."

First, Tao Shoulong burned his company's financial books. He then sold his private golf club memberships and disposed of his Mercedes S-600 sedan.

And then he was gone.

...As more factories in China shut down, stories of bosses running away have become familiar, multiplying the damage of China's worst manufacturing decline in at least a decade.

I don't want to condone disappearing bosses who run off with whatever cash remains and leave behind unpaid employees and suppliers, but there is a simple beauty and efficacy to this process. Capacity is immediately taken out of the market.

Entering this global downturn, it is clear that many industries are suffering from an excess of global production capacity given declining demand. One of the things needed for the global economy to find some support is for production capacity to adjust lower to meet the new lower demand. Basically, factories need to be shut down, and the sooner the better. The fact that Chinese capacity can disappear overnight is actually a good thing for rebalancing the global economy, especially since much of the excess capacity that was built in recent years was built in China.

When these Chinese bosses disappear and their factories are shut down, that production is gone. Contrast that with the typical U.S. corporate bankruptcy. In the U.S., a troubled company files for bankruptcy "protection" and continues to produce. Typically, the stockholders are wiped out, and the bondholders are given new equity in the company in exchange for their debt. Then, the company emerges from bankruptcy, often with a production footprint not terribly different from its pre-bankruptcy days.

So, not only is it likely that zero to modest capacity was taken out of the system, but now the remaining competitors in that industry are facing this "new" old competitor which has a clean balance sheet and can more aggressively compete on price. This puts added pressure on the "survivors" who may have been fairly conservative and done everything right, but nevertheless now face a stronger competitor that would have been liquidated in a true free market. There's probably no better example of this than the U.S. airline industry.

We can bad mouth the Chinese bosses who are leaving their employees and suppliers in a bind, but at least they've found a way to quickly address the excess capacity overhang.

Disclosure: The Rubbernecker is long disappearing Chinese bosses and short the U.S. bankruptcy code.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

U.S. versus China

Everywhere I turn I seem to bump into another article warning investors away from China and cautioning investors from putting money into the Chinese stock market. It never fails to amuse me that this advice always seems to be given AFTER a market has fallen over 50%. Let's take a look at the Chinese stock market and compare it to the S&P500.

The S&P 500 is down about 18.5% from its peak last fall. On a trailing basis, its P/E is 18.4x on an operating basis and 24.7x on a reported basis. Neither are attractive entry levels historically. U.S. GDP growth, corporate earnings growth, and corporate profit margins had all been above trend for many years. It's likely that all three will spend some time below trend over the next few years. Despite a recent rebound in exports, the U.S. still has a large trade deficit, and our national debt, deficit, and unfunded liability position portend further long-term deterioration in the value of the dollar.

China's Shanghai Index is down 60% from its bubbly peak of last fall. On a trailing basis, its P/E is about 16x, which is the lowest it has been in over 10 years. As for growth, the Chinese outlook over the long-term is far more robust than that of the U.S. There will be hiccups and problems along the way, but demographics, rising incomes, and China's cost advantage (even with higher oil/transport prices) are likely to fuel strong growth in China for some time (think decades). Yes, there are plenty of problems in China (as there are everywhere), but what the Chinese have accomplished in just the last 10 years is nothing short of astounding. Furthermore, they have a large trade surplus and a steadily (managed) appreciating currency. In many ways, the Chinese are much better capitalists than we are.

If you have a longer-term investment horizon and were going to buy one of these markets and then ignore it for the next 10 years, which would you buy? Hopefully, that was read as a rhetorical question. Chinese stocks went parabolic and were in a bubble, but they've come down hard to a pretty attractive level.

When will the Chinese market bottom and at what level? No one knows. It will be determined by psychology and valuation. It isn't at all unusual for attractive valuations to become absurdly cheap at the bottom. I wouldn't be at all shocked if the Chinese market traded with a 10 P/E at its bottom. Even with strong earnings growth, that could mean a further 30% drop in the market. For this reason, I've been gradually building a Chinese position since the spring rather than trying to pick a spot. The ultimate size of this position will depend on just how silly things get on the downside relative to other opportunities.

As a reminder, this optimism about Chinese stocks is long-term optimism. Substantial downside over the next quarter or year would hardly be surprising. Turning to that long-term view, the realistic return possibilities built into today's market level are fairly attractive. The table below is very simplistic, but it illustrates the point. It provides the compounded future 10-year returns on the Shanghai index for each set of earnings growth rates (x-axis) and ending P/E values.

		Trailing P/E in 10 years
	10.00	12.50	15.00	17.50	20.00
2.50%	-2.22%	-0.02%	1.82%	3.41%	4.80%
5.00%	0.16%	2.42%	4.31%	5.93%	7.35%
7.50%	2.55%	4.86%	6.79%	8.45%	9.91%
10.00%	4.93%	7.30%	9.27%	10.97%	12.46%
12.50%	7.32%	9.74%	11.76%	13.49%	15.02%
15.00%	9.70%	12.18%	14.24%	16.02%	17.58%
17.50%	12.09%	14.62%	16.73%	18.54%	20.13%
20.00%	14.47%	17.06%	19.21%	21.06%	22.69%

It would hardly be a stretch to imagine trailing P/Es at or above 20 in a more normal environment for a high-growth country. It also doesn't seem unreasonable to imagine earnings growth north of 7.5% per year given consensus expectations for GDP growth and what are likely to be rising margins as China expands more into services and higher value-added manufacturing over time. With these assumptions, the Chinese market would provide an average return in the low double-digit to mid-teen range.

If we happen to see another bubble within the next 10 years and the Chinese market were to trade at the trailing multiple it reached this past fall, the average annual compounded return would move closer to the 20% range. Of course, there are risks. There's always the prospect for political turmoil. Higher wages and transportation costs could severely crimp export growth. No one really has a great handle on the quality of bank assets. A severe global slowdown would also impact growth. If growth disappoints, then earnings multiples are likely to be lower.

There will be hiccups along the way. Despite the inevitable growing pains, the future of China appears to be very bright. Their stock market is a "Rip Van Winkle Buy."

Disclosure: The Rubbernecker is long table tennis, Mah Jong, the number 9, and General Tso tofu.