The Chinese housing market appears to be in a bubble and that bubble appears to be bursting right before our eyes. On my recent trip to China it was impossible not to be impressed with the number of cranes that dotted the skyline of each city I visited. During my meetings and in subsequent meetings at my office, Chinese CEO's defended the housing market with the same answers. "In China owners have to put 30 percent down so banks are protected." "The Chinese economy is growing so fast that the demand for housing from over 1 billion people will support the housing market for a long time." "The Chinese government will never let a disaster like the US housing market happen in China."
While most of this is true it does not negate the two critical facts that China has overbuilt and that the affordability ratio is at an all time low. As with the US, housing bubbles take time to burst. First you have to have overbuilding, then you need prices that take the man in the street out of the market. Finally price increases slow while speculators toss the proverbial hot coal around, but once speculators realize that prices are softening they stampede for the exits and the market bursts.
Currently there are 64 million housing units that are empty and building continues on another 30 billion square feet. The Chinese government recently concluded stress tests at banks based on a 50% drop in the price of housing. A drop of this magnitude would clearly wipe out the home buyers 30% deposit and put the market into a crisis worse than the US.
Why would it be worse? If this were to happen a significant portion of the construction projects underway would be placed into mothballs resulting in millions laid off from work. This could result in the type of social unrest that the Chinese government has feared for years. Furthermore the Chinese government would be forced to implement a massive stimulus program targeting the laid off workers. In other words massive infrastructure projects would be undertaken. Where would all this money come from? More than likely a massive withdrawal from US government bonds.
If this theory works out correctly, expect the global repercussions to be severe as rising interest rates would drag the US economy once more into a recession and this time Bernanke and his Federal Reserve cohorts will have no ammunition left to fight off the collapse.
Friday, October 29, 2010
Thursday, October 21, 2010
Boredom
Now I want to make it clear up front that I do not make this stuff up. It is impossible to do so as who in their right mind would suggest that boredom would be the cure for the US economy's woes. Well your answer is that it was Alan Greenspan, the creator of most of the mess that we are in. That is not to say that Bernanke is not making it better. He is in fact managing to improve on the mess created by Greenspan by creating an even bigger mess!
Can you believe that the hero of the US economy (in many people's eyes) is so ridiculously naive to suggest that boredom will fix the world's problems. His theory is that if the economy remains stable with no growth that eventually executives will just get bored and start to spend money. And to think that he was in charge of the Federal Reserve, hailed as possibly the best ever and now Bernanke is following in his footsteps.
Why people actually feel that the Federal Reserve is doing a good job is beyond me. We have high unemployment, anemic growth, spiralling budget deficits, a lack of faith in all governments and asset bubbles being created before our eyes. Now what is there to cheer? If your investment thesis is based on more quantitative easing helping the economy then I would advise that you recast your thesis before you invest too heavily in an already over bloated stock market.
Can you believe that the hero of the US economy (in many people's eyes) is so ridiculously naive to suggest that boredom will fix the world's problems. His theory is that if the economy remains stable with no growth that eventually executives will just get bored and start to spend money. And to think that he was in charge of the Federal Reserve, hailed as possibly the best ever and now Bernanke is following in his footsteps.
Why people actually feel that the Federal Reserve is doing a good job is beyond me. We have high unemployment, anemic growth, spiralling budget deficits, a lack of faith in all governments and asset bubbles being created before our eyes. Now what is there to cheer? If your investment thesis is based on more quantitative easing helping the economy then I would advise that you recast your thesis before you invest too heavily in an already over bloated stock market.
Wednesday, October 20, 2010
Good News is not Always Good
Once again the cheerleaders on Wall Street were out in full force pointing out all the advances in price today. The thought suddenly struck me that most people view all this chatter as positive and that prices going up is "always" a good thing. One would think that in all cases a bull market is the best cure for all evils and that a bear market hurts all and sundry. This in not always the case.
Today the best rally came from grain commodities. As a group they were up over 3%. Let's think about this for a minute. Up 3% means that prices at the grocery store will continue to rise as the feedstocks seep into the prices of everything from our cereal to the price we pay for beef and poultry. At a time when the consumer is already strapped this will hurt economic growth.
Now let's turn to the price of houses. Certainly in general an upward move in the price of housing is good for an economy. What of our current economic environment. Falling house prices mean that the inventory of houses will clear quicker as more and more people are able to afford what they previously could not. Eventually the low prices will clear out the overhead allowing prices to appreciate once again and benefiting the economy. As long as prices are propped up artificially this cannot happen and this can mean long periods of slow or no growth.
The rally in stocks can suck in the innocent looking for a quick reward. Earning next to nothing in their savings accounts the Federal Reserve is begging people to risk their hard earned savings on risky investments one of which is a punt on the stock market. As prices spiral higher it gets harder and harder for the public to sit on the sidelines. As time has proven over and over again, just as soon as the public jumps in the wind leaves the sails of the market. It appears that this is another setup waiting for the public to take the bait.
I would prefer to see a market that is based on rational investment at a reasonable price than the current market that is filled with speculation. This to me means that a bear market is a benefit rather than a curse. Obviously I am aware that this would mean that the public will be stung for another loss; but until the economy is on a solid footing it would be preferrable for the public to continue with their austerity measures as this will help in righting the economy far more quickly than investing in another speculative market.
My view (which is based on where we are in the current economic cycle) is that prices should be let to fall to a point where we can clear the dead wood out of the barn and make way for the new season. As long as we tinker with the normal functions of a free market we will continue to drag this economic turmoil out for an extended period. Therefore I for one do not applaud the current market rally but see it as another vain attempt to prop up a weak market that is in desperate need of being washed clean. One thing I do know is that the old axiom of the commodity market: "High prices end high prices." I have no doubt that at some point the high prices in stocks, commodities and real estate will undermine the "recovery" and we will once again find ourselves in another bear market.
Today the best rally came from grain commodities. As a group they were up over 3%. Let's think about this for a minute. Up 3% means that prices at the grocery store will continue to rise as the feedstocks seep into the prices of everything from our cereal to the price we pay for beef and poultry. At a time when the consumer is already strapped this will hurt economic growth.
Now let's turn to the price of houses. Certainly in general an upward move in the price of housing is good for an economy. What of our current economic environment. Falling house prices mean that the inventory of houses will clear quicker as more and more people are able to afford what they previously could not. Eventually the low prices will clear out the overhead allowing prices to appreciate once again and benefiting the economy. As long as prices are propped up artificially this cannot happen and this can mean long periods of slow or no growth.
The rally in stocks can suck in the innocent looking for a quick reward. Earning next to nothing in their savings accounts the Federal Reserve is begging people to risk their hard earned savings on risky investments one of which is a punt on the stock market. As prices spiral higher it gets harder and harder for the public to sit on the sidelines. As time has proven over and over again, just as soon as the public jumps in the wind leaves the sails of the market. It appears that this is another setup waiting for the public to take the bait.
I would prefer to see a market that is based on rational investment at a reasonable price than the current market that is filled with speculation. This to me means that a bear market is a benefit rather than a curse. Obviously I am aware that this would mean that the public will be stung for another loss; but until the economy is on a solid footing it would be preferrable for the public to continue with their austerity measures as this will help in righting the economy far more quickly than investing in another speculative market.
My view (which is based on where we are in the current economic cycle) is that prices should be let to fall to a point where we can clear the dead wood out of the barn and make way for the new season. As long as we tinker with the normal functions of a free market we will continue to drag this economic turmoil out for an extended period. Therefore I for one do not applaud the current market rally but see it as another vain attempt to prop up a weak market that is in desperate need of being washed clean. One thing I do know is that the old axiom of the commodity market: "High prices end high prices." I have no doubt that at some point the high prices in stocks, commodities and real estate will undermine the "recovery" and we will once again find ourselves in another bear market.
Monday, October 18, 2010
The End of the Baby Boomer
This certainly is not news. The baby boomer generation is definitely at the end of its productive life cycle and is headed into the retirement phase, but this demographic shift certainly brings with it a change in the way that we should look at the American economy going forward.
Think of health care. The system was recently "improved" to capture millions of uninsured Americans just when the demographic shift makes the hole in this budget item even more acutely painful. The health care investment thesis basis its analysis on the spending side of the equation and to be sure this should accelerate as more and more baby boomers advance in age. However as more and more baby boomers die there is less and less demand and as time goes by this demand will fall off a cliff.
In addition just as the cost of financing health care and a burgeoning budget deficit spiral ever upward, the base of tax payers paying the bulk of the taxes (the middle class) will level off and could even shrink. This is not a long term trend that bodes well for future government plans to reign in spending. Just take one look at the struggle that Japan is having since their bubble population moved into the retirement years. At present Japan's pension fund is liquidating assets at 5 times its normal rate to support pension payments and the economy is still struggling 20 years after the Nikkei peaked. This could easily point toward an extended period of contraction in the US economy and is certainly not a scenario that the market or the Federal Reserve is taking seriously at present.
Furthermore the age at which people are getting married is rising rapidly. This bodes poorly for population growth and for housing. Home ownership is far more likely when married than when single. Married couples normally have less children the older they are. Less children mean less demand in the future and less marriages mean less demand for housing at present. Certainly not an ideal situation for the housing sector particularly in this poor economic environment.
Now do not get me wrong, this is not going to happen overnight. Demographic shifts happen over decades and not minutes, but it certainly is a theme that should be monitored and should slowly be factored into your investment strategies going forward. At the very least these demographic trends point towards an extended slow down in the US economy for at least the next decade and maybe longer.
Think of health care. The system was recently "improved" to capture millions of uninsured Americans just when the demographic shift makes the hole in this budget item even more acutely painful. The health care investment thesis basis its analysis on the spending side of the equation and to be sure this should accelerate as more and more baby boomers advance in age. However as more and more baby boomers die there is less and less demand and as time goes by this demand will fall off a cliff.
In addition just as the cost of financing health care and a burgeoning budget deficit spiral ever upward, the base of tax payers paying the bulk of the taxes (the middle class) will level off and could even shrink. This is not a long term trend that bodes well for future government plans to reign in spending. Just take one look at the struggle that Japan is having since their bubble population moved into the retirement years. At present Japan's pension fund is liquidating assets at 5 times its normal rate to support pension payments and the economy is still struggling 20 years after the Nikkei peaked. This could easily point toward an extended period of contraction in the US economy and is certainly not a scenario that the market or the Federal Reserve is taking seriously at present.
Furthermore the age at which people are getting married is rising rapidly. This bodes poorly for population growth and for housing. Home ownership is far more likely when married than when single. Married couples normally have less children the older they are. Less children mean less demand in the future and less marriages mean less demand for housing at present. Certainly not an ideal situation for the housing sector particularly in this poor economic environment.
Now do not get me wrong, this is not going to happen overnight. Demographic shifts happen over decades and not minutes, but it certainly is a theme that should be monitored and should slowly be factored into your investment strategies going forward. At the very least these demographic trends point towards an extended slow down in the US economy for at least the next decade and maybe longer.
Thursday, October 14, 2010
Inflation is Coming
For a while now it has appeared that the level of inflation will be held down with the two inflation busters of high unemployment and factory capacity. These two have provided a buffer against inflation for more than a year but it has always been my contention that with all the quantitative easing happening around the globe that eventually there would be inflation even with no growth. The economic term for an economy with high unemployment and high inflation is stagflation.
Stagflation seems to be taking hold right before our eyes as this morning producer prices once again moved higher by 0.4 percent which was the same level of increase as was reported in August. This was "unexpected" as it was consensus that August was an anomaly. Now for all of you that trade futures and commodities like I do you would have known that this was anything but an anomaly.
Oil is over $80 per barrel, all the grains are at or near new twelve month highs, sugar and cocoa are trending higher and gold (the official barometer of inflation) has broken to all time highs. The official reason for the big jump was due to finished foods specifically meat and poultry. The reason for their move higher was a 26 percent increase in the price of corn which is used to feed these animals. So the inputs (raw materials) are finally starting to feed through to the output prices and this will lead to inflation.
Why do these prices continue higher? As the Federal Reserve continues to print money the dollar is plummeting, This will result in a move higher in the price of internationally traded commodities such as oil, grains and softs. In the end this will and has always lead to inflation. The question is when will the Federal Reserve try to combat it?
My answer is that they will wait too long mainly due to the fact that they believe it is under control. In addition attacking inflation now will result in another recession as it will choke off any growth and will certainly destroy a fragile housing market and banking sector. For these reasons they will leave rates too low for too long and the result will be high inflation with no growth for an extended period. My advice is to be prepared for a long dry spell in stocks (other than those tied to commodity prices) as the money will be made in commodities.
Stagflation seems to be taking hold right before our eyes as this morning producer prices once again moved higher by 0.4 percent which was the same level of increase as was reported in August. This was "unexpected" as it was consensus that August was an anomaly. Now for all of you that trade futures and commodities like I do you would have known that this was anything but an anomaly.
Oil is over $80 per barrel, all the grains are at or near new twelve month highs, sugar and cocoa are trending higher and gold (the official barometer of inflation) has broken to all time highs. The official reason for the big jump was due to finished foods specifically meat and poultry. The reason for their move higher was a 26 percent increase in the price of corn which is used to feed these animals. So the inputs (raw materials) are finally starting to feed through to the output prices and this will lead to inflation.
Why do these prices continue higher? As the Federal Reserve continues to print money the dollar is plummeting, This will result in a move higher in the price of internationally traded commodities such as oil, grains and softs. In the end this will and has always lead to inflation. The question is when will the Federal Reserve try to combat it?
My answer is that they will wait too long mainly due to the fact that they believe it is under control. In addition attacking inflation now will result in another recession as it will choke off any growth and will certainly destroy a fragile housing market and banking sector. For these reasons they will leave rates too low for too long and the result will be high inflation with no growth for an extended period. My advice is to be prepared for a long dry spell in stocks (other than those tied to commodity prices) as the money will be made in commodities.
Tuesday, October 5, 2010
India versus China
There is much debate over whether India will be able to eclipse China's growth. Having recently visited China I have to say that this may be a stretch in the near term (5 to 10 years). Post this period India may well have its day.
To start with China has far superior foreign currency reserves, infrastructure and a government that will not let anything or any person in its way to stop their meteoric rise. Every policy is aimed at making it the next economic super power and their desire seems to be far more focused and intent than India's. That said there may be blocks to growth in the longer term.
India for all its drawbacks has a few things that make it appealing for the long term. First they have a better demographic due to China's restrictive one child policy. This will serve them well in the long term as their youth of today power India's growth of tomorrow. Just look at how it benefited the USA during the baby boom generation.
Second, being a democratic country has enabled superior levels of competition. China on the other hand has the government's finder prints all over large business operations and it is difficult to see how this will benefit them in the long run or how easily they will be able to extract themselves from these companies to foster competitive growth. At some point they must let these companies survive on their own if they are to become true global players and at present it is difficult to see the Chinese government giving up control.
Finally, India is far safer from an intellectual property stand point. This is why most of the large technology companies prefer to use India as a low cost hub rather than China where copying intellectual property is common place.
It will be interesting to see if over time India can repair its broken infrastructure and bring it up to the international standards required to move it into an economic super power, or whether China will be able to transition to a more open market economy that fosters competition over government intervention while cracking down on the breaches of international intellectual property law.
Personally I will remain more heavily invested in China for the foreseeable future but will continue to be watchful of a sustained Indian growth wave that will create investment opportunities.
To start with China has far superior foreign currency reserves, infrastructure and a government that will not let anything or any person in its way to stop their meteoric rise. Every policy is aimed at making it the next economic super power and their desire seems to be far more focused and intent than India's. That said there may be blocks to growth in the longer term.
India for all its drawbacks has a few things that make it appealing for the long term. First they have a better demographic due to China's restrictive one child policy. This will serve them well in the long term as their youth of today power India's growth of tomorrow. Just look at how it benefited the USA during the baby boom generation.
Second, being a democratic country has enabled superior levels of competition. China on the other hand has the government's finder prints all over large business operations and it is difficult to see how this will benefit them in the long run or how easily they will be able to extract themselves from these companies to foster competitive growth. At some point they must let these companies survive on their own if they are to become true global players and at present it is difficult to see the Chinese government giving up control.
Finally, India is far safer from an intellectual property stand point. This is why most of the large technology companies prefer to use India as a low cost hub rather than China where copying intellectual property is common place.
It will be interesting to see if over time India can repair its broken infrastructure and bring it up to the international standards required to move it into an economic super power, or whether China will be able to transition to a more open market economy that fosters competition over government intervention while cracking down on the breaches of international intellectual property law.
Personally I will remain more heavily invested in China for the foreseeable future but will continue to be watchful of a sustained Indian growth wave that will create investment opportunities.
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