What’s this? The ASX200 fell almost two percent yesterday. So much for the rate cut…
We’d given up watching stock market action. After so many years just a few percent either side of the 4600 mark, market watching gets boring. In fact, that kind of market action makes dividends look exciting.
With election campaigning in full swing here in Australia and financial markets going nowhere, let’s look elsewhere for some relief. We’ll take a world tour…
In America, there’s some concern about whether company earnings can keep up with the stock market. So far, it looks like the rally in American stocks (in green) is quite justified based on the profits companies are earning (in white).
In 2000, it was quite clear that stocks had gotten ahead of themselves, with a profitless rally leading to a stock market crash. This time around, profits and share prices rallied together.
But the chart may be misleading. Investment adviser and valuation guru John Hussman recently pointed out in John Mauldin’s newsletter Outside the Box that we could be in an earnings and stock market bubble this time around:
‘On the earnings front, my concern continues to be that investors don’t seem to recognize that profit margins are more than 70% above their historical norms, nor the extent to which this surplus is the direct result of a historic (and unsustainable) deficit in the sum of government and household savings. As a result, investors seem oblivious to the likelihood of earnings disappointments, not only in coming quarters but in the next several years. We continue to expect this disappointment to amount to a contraction in earnings over the next 4 years at a rate of roughly 12% annually.
‘Corporate profits are nothing if not mean-reverting. There are several explanations for this phenomenon; but whatever the cause, the current off-the-charts percentage of profits to GDP is highly unlikely to become an enduring feature of the New Normal. Especially not given the recent weakness across the rest of the data spectrum.’
On cue, the US economy may be entering a ‘revenue recession’, with a second quarter of falling revenue on the cards. The first quarter of 2013 posted a 0.6% drop in earnings and we’re more than halfway through the second quarter’s earnings announcements, with mixed results so far.
A drop in earnings would be a fascinating development, because it singles out whether money printing can levitate stocks in the face of poor company prospects. In other words, we’d find out what drives the stock market — money printing or profits?
As we often tell Money for Life Letter subscribers, the whole point of owning a stock is your claim on its ability to make money. Small business owners understand this because they rely on the income their business generates. For some reason, stock market investors forget that an investment is worth what it pays.
If earnings in America fall, this reality could come back to bite. On the other hand, the inflation Bernanke is creating at the Federal Reserve could go straight into stocks, profits or no.
Still in America, but on the consumer’s side of things, it’s all sunshine, lollipops and rainbows. According to Bloomberg: ‘Household net worth soared to a record high in the first quarter, Federal Reserve data show, and the financial-obligations ratio relating consumer debt to income matched the lowest in 33 years.’
Aussie investors who bought into the American housing market back when there was blood in the streets are breathing a sigh of relief. House prices are rising fast and the American President recently reaffirmed that the government would continue to backstop their investment via GSEs like Fannie Mae and Freddie Mac.
Over in Europe, the IMF is criticising the one Eurozone country that’s handling the crisis well. It says Germany needs to get its exports under control, and ‘fiscal over-performance should be firmly avoided’. We almost choked on a grape when we read the second line.
Germany isn’t terribly far behind the worst European countries when it comes to debt. And the Germans aren’t forcing anyone to buy their stuff, so telling them to export less seems a little thick. As for imports, if the Greeks made BMWs, the Germans would be happy to buy them. But they don’t.
Meanwhile, the French are crossing the Rhine again. Only this time they’re looking for work. ‘In Germany, they take people more easily and train them for new work even if you have worked in a totally different area than the one asked for,’ says one French lady who took up a job in a German toy store. Quite frankly, having a French person working in a German toy store is like having a New Zealander coach Collingwood. But you’ve got to be diplomatic these days.
The French/German borderlands show how regulatory influences can affect an economy. Many of the people living on the border are bilingual anyway, and share much the same culture. But they’re still a world apart when it comes to unemployment rates and working conditions.
Finishing our tour of the world, let’s go to China. The key to understanding the place is a border of a different sort — a language barrier. For the last three hundred years, the language of the West has been money. Everything comes down to a price. Once you agree on the price, you’ve got a binding contract. Both sides must meet their terms. Prices and contracts are also an international language, which helps when you trade with a foreigner.
The Chinese see things very differently. First of all, status, dignity and honour are far more important than money. BlueScope Steel set up a factory in China which we visited years ago. The Aussie tour guide who showed us round had some funny stories about the culture shock the company had been through.
Each time one of the Chinese locals they hired finished training, he would leave for a Chinese steel firm which paid less. The Aussie management couldn’t figure out why.
They eventually discovered that it all came down to job titles. Being Aussie steel workers, management didn’t give a flying…thought about job titles. They cared about their income. But the company quickly found the Chinese were the opposite. They had to hand over their income to the extended family as soon as they got home, and then receive their cut, so income mattered little. Job titles were everything.
BlueScope fixed the problem by inventing the title ‘Grand Poobah’ and telling all the Chinese it was by far the best thing you could have on your business card. (The tour guide was probably joking about that part.)
Anyway, all this puts Chinese manipulation of statistics in perspective. It’s not surprising at all. Statistics are a tool for propaganda and encouragement, not a reflection of cash flow reality. There are far more important things in life than accurate statistics!
The funny thing is that western economists are spending countless hours pouring over the same statistics with advanced mathematical models. Somebody will get a Nobel Prize using Chinese data to prove some bizarre economic theory someday.
Another point of difference between the West and China is how the Chinese see contracts. They see an agreement as something that is always developing and changing. If both sides don’t perceive themselves as benefitting, then the agreement becomes null and void.
None of this translates well into Western thinking. People who aren’t motivated by cash? Contracts that change over time? You could put the odd differences down to Communism or collectivist culture. In that environment, status is currency, after all. Whether the Chinese mentality is backward or advanced is difficult to say. There’s no objective judgement you can apply.
In our latest issue of The Money for Life Letter we pointed out that economies which throw off the collectivist mentality experience economic booms. But if prices aren’t your measure of success, is GDP a fair measure? Perhaps it should be national glory or how much you can annoy the Americans without having them invade you? Each to his own…
A book we heard about but never read (and can’t remember the name of) advocates exploiting the current debt based monetary system for all its worth and then letting the thing blow up. It sounds stupid, but here’s the logic. By borrowing like mad, vastly overinvesting and then vastly overproducing, a society can create vast amounts of goods, resources and physical capital like machines and equipment.
Then, when the financial and monetary system blows up, you’re left with an economy with enormous potential, but without a financial sector to corrupt things. If you measure success in terms of real stuff and not money, you’d be in great shape.
In a sense, that’s just what the Chinese are doing. They’ve built entire cities for nobody in particular. They’ve built factories that can produce for a consumer on borrowed time (indebted Americans). According to Jim Chanos, they’re building enough office space for every man woman and child in China to have their own cubicle.
But at least they’ve got something to show for all their spending and borrowing. Even if house prices tumble, banks blow up and people are impoverished, bankruptcy is a lot easier to recover from if you’ve got a load of useful stuff lying around.
The problems with this mentality are plentiful. And it doesn’t raise Chinese stock prices, which have been a shambles. The Shanghai Composite index is down around 40% from 2009 highs. Unlike the Americans, the Chinese don’t goose their stock prices.
A less popular indicator is just as convincing. The Chinese have broken ground on what will be the world’s tallest building. The problem with world’s tallest buildings throughout history is that they signal the onset of economic depressions. It only makes sense to build them when times are at their most euphoric. And euphoric times tend to be followed by a crash.
As a Chinese person might say, if there is another financial crisis, at least China will have the tallest building in the world for many years to come. That’s the whole point of a building, isn’t it?
You might think of the Chinese as odd, unsuccessful and in deep economic trouble. Even if you disagree with abusing debt based money for what it’s worth, the Chinese do have another significant advantage. They make incompetent and corrupt government officials ‘disappear’. Here in Australia, they run for re-election.
Official records list the missing Chinese bureaucrats as ‘absent’ or on ‘sick leave.’ But unless there’s some kind of virus going around, there are far too many people being struck off the list during an investigation into corruption. Anyway, perhaps we can learn something from the Chinese after all.
And now we’re back in Australia. What did you learn on your travels? Give me 5000 on the ASX200 any day.
for The Daily Reckoning Australia
From the Archives…
The Global Trend Towards Wealth Protection
01-08-2013 – Greg Canavan
Here’s Why You Should Beware the Financial Planning Mantra
31-07-2013 – Vern Gowdie
A Narcissistic Financial System
30-07-2013 – Greg Canavan
Living in a Keynesian Fictional Paradise
27-07-13 – Nick Hubble
Has the Chinese Economy Hit the Great Wall?
26-07-13 – Bill Bonner