Over-rated European problems plus... Marc Faber turns bearish on China
I haven't posted much lately and I haven't found any attractive investment opportunities. Like I alluded to in a post a week ago, comparing the present to the 1930's, valuations have gone so quickly from slightly undervalued to overvalued. Yet, there have been some major developments in the background. The issues pertain to macroeconomic matters and is probably ignored by some, but I wouldn't ignore them.
What's making the news comes from the ugly houses in Europe...some of the countries whose ancient civilizations used to represent the pinnacle of humanity on earth... now reduced to the so-called PIGS. But a greater looming problem lies in China. Marc Faber appears to have turned bearish on China.
Over-rated European Problems
The first big issue is the deteriorating situation with certain over-indebted countries in Europe—the so-called PIIGS. Portugal, Ireland, Italy, Greece, and Spain—although Italy is nowhere near as badly off as any of these and probably doesn't belong on this list—had been talked about for years but the breaking point appears to have been reached. I don't know if I mentioned it on this blog but when I was following investment house, GaveKal, a few years ago, I remember their bearish view of some of these countries. In fact, they started a fund that bet against the Euro based on the thesis that it won't be able to handle the fiscal problems in these countries. Jim Rogers, as some may recall, has also suggested that the Euro will fail (although I'm not sure if he was serious or was exaggerating to make the news.)
For what it's worth, I don't think the PIIGS situation is a big deal unless you live in those countries. None of it is news and the markets are more vulnerable to surprises than events that have been percolating for years. The impact is likely to be on currencies and trade balances, rather than on asset prices. Assets, such as stocks and real estate, hold their value through crises so I don't expect much out of the current Euro problem. David Rosenberg of Gluskin Sheff + Associates suggests that a bailout of impacted European countries may approach $800 billion but this is nothing compared to the financial crisises we have been through. The residential subprime losses alone are as much as that, and we had huge losses in prime residential mortgages, commercial real estate, and so forth.
China & Its Storms
If you want a surprise that can move the markets, I think one needs to look at China. In particular, consider what happens if China's various bubbles (real estate, manufacturing, etc) blows. No one know if there are actually bubbles or if it will collapse but do consider the possibility of what would happen if they do blow.
Another very-low probability event that could shock the market is if China devalues the currency. Almost every single person is expecting the renminbi to appreciate but a crisis could force it to devalue. This may materialize if their manufacturing suffers, as it will if external demand falls. China devalued the currency in the late 90's, during the Fall of the Asian Tigers, and a similar outcome is not out of the realm of possibility. I am not predicting this and I hope it doesn't happen—it will set off a huge trade war and possibly drag the world into the modern-equivalent of a depression—but as an investor who is bearish on China, I do think about it. I wouldn't bet on it but I would be prepared in case...
Although there are some bearish views making the mainstream these days, that alone doesn't mean a bubble won't blow. If you recall, there were quite a number of bearish articles on American real estate near the peak including several bearish articles in The Economist and a timely opinion piece by Paul Krugman on August 8th of 2005, "That Hissing Sound" (Krugman gets some things wrong but this was a great call right at the top. Housing basically peaked in 2005 although no one paid attention until the Bear Stearns hedge funds collapsed in 2008.) Similarly, the numerous bearish articles on China does not necessarily mean that a bubble doesn't exist.
The latest person to turn bearish on China is Marc Faber. As long time readers know by now, I'm a big fan of Marc Faber. I haven't shared his stance ever since he turned bullish on commodities a while ago. His view ultimately turned out to be correct and mine was wrong. Presently, however, I think our stance is becoming similar. He finally appeared to have turned bearish on China. In a Bloomberg video interview (if link doesn't work, go here and click on video near the top,) he even considers the possibility of a major crash within 12 months (thanks to Business Insider for bringing this to my attention.)
I think it is a mistake to look at China's stock market performance as a leading indicator. I think too many people brought up in developed countries assume the Chinese stock market provides price discovery and I beg to disagree. China's stock market is a tiny portion of the economy, is largely closed to capital flows, and resembles a gambling den more than anything. If you want to look at market-based price indicators, I think the best ones, as Marc Faber alludes to, are industrial commodities (Faber also looks at the Chinese stock market but I disagree with him.) Industrial commodities are very sensitive to China because almost all the incremental demand is coming from there—and keep in mind that commodity prices are set at the margin.
Due to his bearish view on China, Marc Faber says he is bearish on industrial commodities. Instead, he says he likes soft commodities and precious metals. I don't share his bullish views on soft commodities and precious metals like gold. Depending on which bubble blows in China—I'm one of the few who thinks real estate is not the only bubble; manufacturing and fixed assets like railways/airports/etc are possible bubbles as well—I think the outcome will be deflationary. The US$ should strengthen and this should be bearish for gold, as well as commodities in general.
It will probably be impossible to avoid some sort of deflationary outcome if Chinese GDP collapses due to the bursting of, say, the real estate bubble. China just has huge overcapacity and deflation is a natural outcome in those cases.
Some people think you will end up with inflation because of money printing or a currency devaluation but economics is not so simple. If you look at how much money Japan printed in the last 20 years, you'll see how difficult it is to raise the GDP. Similarly, during the 1930's, the US government tried all sorts of techniques to raise prices, such as increased government spending and the devaluation of the currency (against gold,) but it was very difficult to raise GDP growth. In some cases, you can raise nominal GDP through printing money but real GDP is still hard to increase.
Having said all that, if China were to become the next big economic power, it needs to overcome the bursting of any bubble. Building a fancy house for sunny weather is good and all; but it's the storm that determines how good your house is.
What's making the news comes from the ugly houses in Europe...some of the countries whose ancient civilizations used to represent the pinnacle of humanity on earth... now reduced to the so-called PIGS. But a greater looming problem lies in China. Marc Faber appears to have turned bearish on China.
Over-rated European Problems
The first big issue is the deteriorating situation with certain over-indebted countries in Europe—the so-called PIIGS. Portugal, Ireland, Italy, Greece, and Spain—although Italy is nowhere near as badly off as any of these and probably doesn't belong on this list—had been talked about for years but the breaking point appears to have been reached. I don't know if I mentioned it on this blog but when I was following investment house, GaveKal, a few years ago, I remember their bearish view of some of these countries. In fact, they started a fund that bet against the Euro based on the thesis that it won't be able to handle the fiscal problems in these countries. Jim Rogers, as some may recall, has also suggested that the Euro will fail (although I'm not sure if he was serious or was exaggerating to make the news.)
For what it's worth, I don't think the PIIGS situation is a big deal unless you live in those countries. None of it is news and the markets are more vulnerable to surprises than events that have been percolating for years. The impact is likely to be on currencies and trade balances, rather than on asset prices. Assets, such as stocks and real estate, hold their value through crises so I don't expect much out of the current Euro problem. David Rosenberg of Gluskin Sheff + Associates suggests that a bailout of impacted European countries may approach $800 billion but this is nothing compared to the financial crisises we have been through. The residential subprime losses alone are as much as that, and we had huge losses in prime residential mortgages, commercial real estate, and so forth.
China & Its Storms
If you want a surprise that can move the markets, I think one needs to look at China. In particular, consider what happens if China's various bubbles (real estate, manufacturing, etc) blows. No one know if there are actually bubbles or if it will collapse but do consider the possibility of what would happen if they do blow.
Another very-low probability event that could shock the market is if China devalues the currency. Almost every single person is expecting the renminbi to appreciate but a crisis could force it to devalue. This may materialize if their manufacturing suffers, as it will if external demand falls. China devalued the currency in the late 90's, during the Fall of the Asian Tigers, and a similar outcome is not out of the realm of possibility. I am not predicting this and I hope it doesn't happen—it will set off a huge trade war and possibly drag the world into the modern-equivalent of a depression—but as an investor who is bearish on China, I do think about it. I wouldn't bet on it but I would be prepared in case...
Although there are some bearish views making the mainstream these days, that alone doesn't mean a bubble won't blow. If you recall, there were quite a number of bearish articles on American real estate near the peak including several bearish articles in The Economist and a timely opinion piece by Paul Krugman on August 8th of 2005, "That Hissing Sound" (Krugman gets some things wrong but this was a great call right at the top. Housing basically peaked in 2005 although no one paid attention until the Bear Stearns hedge funds collapsed in 2008.) Similarly, the numerous bearish articles on China does not necessarily mean that a bubble doesn't exist.
The latest person to turn bearish on China is Marc Faber. As long time readers know by now, I'm a big fan of Marc Faber. I haven't shared his stance ever since he turned bullish on commodities a while ago. His view ultimately turned out to be correct and mine was wrong. Presently, however, I think our stance is becoming similar. He finally appeared to have turned bearish on China. In a Bloomberg video interview (if link doesn't work, go here and click on video near the top,) he even considers the possibility of a major crash within 12 months (thanks to Business Insider for bringing this to my attention.)
I think it is a mistake to look at China's stock market performance as a leading indicator. I think too many people brought up in developed countries assume the Chinese stock market provides price discovery and I beg to disagree. China's stock market is a tiny portion of the economy, is largely closed to capital flows, and resembles a gambling den more than anything. If you want to look at market-based price indicators, I think the best ones, as Marc Faber alludes to, are industrial commodities (Faber also looks at the Chinese stock market but I disagree with him.) Industrial commodities are very sensitive to China because almost all the incremental demand is coming from there—and keep in mind that commodity prices are set at the margin.
Due to his bearish view on China, Marc Faber says he is bearish on industrial commodities. Instead, he says he likes soft commodities and precious metals. I don't share his bullish views on soft commodities and precious metals like gold. Depending on which bubble blows in China—I'm one of the few who thinks real estate is not the only bubble; manufacturing and fixed assets like railways/airports/etc are possible bubbles as well—I think the outcome will be deflationary. The US$ should strengthen and this should be bearish for gold, as well as commodities in general.
It will probably be impossible to avoid some sort of deflationary outcome if Chinese GDP collapses due to the bursting of, say, the real estate bubble. China just has huge overcapacity and deflation is a natural outcome in those cases.
Some people think you will end up with inflation because of money printing or a currency devaluation but economics is not so simple. If you look at how much money Japan printed in the last 20 years, you'll see how difficult it is to raise the GDP. Similarly, during the 1930's, the US government tried all sorts of techniques to raise prices, such as increased government spending and the devaluation of the currency (against gold,) but it was very difficult to raise GDP growth. In some cases, you can raise nominal GDP through printing money but real GDP is still hard to increase.
Having said all that, if China were to become the next big economic power, it needs to overcome the bursting of any bubble. Building a fancy house for sunny weather is good and all; but it's the storm that determines how good your house is.
Siv,
ReplyDeleteYou should get Disqus for your comments. FYI, I think there's another "i" in PIIGS (for Ireland and Iceland).
Re China, you may want to see the recent discussion here. As I recounted there, Gary Shilling makes a compelling near-term bear case for China. Which would be bad for my largest stock holding. So I own some puts on a leading iron ore exporter to China as a hedge.
When I was investigating commenting systems, I looked at Disqus but ruled it out. I forget the reason but I believe it's because the comments are hosted on their servers and not tied to the blog per se. Echo, formerly js-kit, was supposed to sync with Blogger's native comments (so that if you remove it, the comments would remain.) Things have changed (it isn't quite as free as it was before; the synching doesn't seem to work at times; etc) but I still like it more.
ReplyDeleteOverall, I'm not satisfied with any of the commenting systems. It's too bad that Blogger hasn't put any resources into improving their native system. Blogger has made few minor changes here and there but I suspect they need to re-architect the whole thing to satisfy me *DONT_KNOW*
CHINA
Do you have any recent comments (last 2 months) from Shilling? I'm not exactly sure what you are referring to. The most comprehensive bear case I have seen is by Edward Chancellor at GMO, who should be an expert on bubbles given the books he has written on them.
If China sees a real estate crash, everyone is going to be negatively impacted. The obvious sectors, such as iron ore companies, will be hit harder than most but it will be difficult to get out without losses regardless of what you hold.
When Japan's real estate blew in 1990, it was mostly isolated to Japan but I don't think the same thing will happen with China. Not only is China a big player in world trade, the economic growth of the world is quite weak and can't witstand the loss of confidence by investors and businesspeople.
The big questions if such a thing does materialize are: who will take the losses, and what will the secondary effects be?
I checked out the link to your site and I think you were talking about this Shilling interview.
ReplyDelete