Here’s an interesting pair trade to begin your day with: sell China and buy Goldman Sachs. Okay, okay. It sounds ludicrous. But let’s consider some facts.
Both the S&P 500 and the Dow Jones Industrials closed up about 2.5% overnight. Analysts upgraded estimates for Goldman’s earnings. That sparked a buying frenzy in bank and financial stocks, which took markets higher. Presto, change-o, everything is bull again.
Or is it? We’d suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America. However, that doesn’t mean the pair trade doesn’t have legs. In fact, have a look at the chart below and you might be convinced it’s time to buy the S&P!
Thanks to massive stimulus from China beginning in November, there’s been an explosion in consumer and business lending. That’s translated, we’d suggest, into asset inflation. Exhibit “A” is the nearly 75% year-to-date climb in Shanghai’s benchmark CSI 300 index. It has, as you can see, trounced the return in U.S. stocks.
Now there’s more than one way to interpret this chart (this is what makes charts so intriguing but frustrating.) Is this the market’s verdict on U.S. growth prospects and Obama’s trillion dollar deficit plans? Is it vindication that China’s stimulus has been a lot more successful and promoting real economic growth than the $787 billion pile of junk passed by the U.S. Congress?
Or how about a third theory? Is it evidence that China is in the accelerating phase of its own massive credit bubble? And could the collapse of this credit bubble lead to a Chinese Day of Reckoning?
If that’s the case, then it would be time to sell commodities and buy Goldman, or at least time to sell commodities. A collapsing Chinese credit bubble would remove a lot of the demand and price support for Australian commodities (especially coking coal and iron ore). We covered the story while filling in for Kris Sayce at Money Morning today. You can read the whole story over www.moneymorning.com.au.
While we’re on the subject of stimuli, a New York Times story from yesterday suggest that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble. But the evasion is like hiding under the bed from the bogeyman. He’s still going to get you. Sucking your thumb and pretending otherwise won’t help.
“The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,” says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. “It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.”
This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now. The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they’d got a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent). Yet many banks are under the absurd illusion that if they hold certain assets to maturity, they won’t suffer any losses.
This is the same as saying million of Americans are going to make their mortgage payments as they lose their jobs and find themselves underwater and unable to refinance. The default and foreclosure data coming out of the U.S. housing market suggest the banks are kidding themselves, or misleading shareholders, or both!
It’s the sort of calculated mis-truth that can cause a short-term crisis to last years and years. The correction is postponed through phoney accounting. It leads to a Ushinwareta Junene, or a lost decade, as the Japanese say. We prefer the Zombie metaphor-an economy full of living dead loans that threaten to infect the real live survivors.
In a ten (or even 17 year period like that) you get low growth, high unemployment, and stock market benchmarks that do not keep up with inflation. Stocks as an asset class perform poorly. Bonds, on the other hand, might go through rallies and corrections and be more tradeable (or rally on deflation concerns, as Marc Faber pointed out late last week).
But whatever happens in ten years from now, it’s pretty clear that the “doing something is better than doing nothing” mantra of Keynesian intervention is a big fat deficit-adding failure. Unemployment is rising. The economy is not fundamentally better off. And bank balance sheets retain a whiff of unreality. More spending cannot be the answer when too much credit was the problem.
-Phillip J. Anderson is one of our panellists at the upcoming “Australia in the Red” summit in Melbourne on Friday, July 21st at the State Library of Victoria. In his book “The Secret Life of Real Estate,” he explains a 17-year cycle in property prices related to land values.
Fortunately for Aussies, the cycle heads mostly up. Not so fortunately, there are periods in the cycle where it corrects and falls in real terms. If you buy near the top and prior to a four-year period of decline, it can be bad for your financial plans.
We’re not sure why, but this idea that cycles run in 17 or 18 year periods keeps cropping up. Last week on CNBC, Art Cashin made exactly the same point. He pointed out that from 1966 to 1982, the Dow Jones traded in a range.
If you began investing in 1966, you didn’t make much money for the better part of two decades. On the other hand, the 1982 to 2000 cycle witnessed one of the greatest bull markets of all time in stocks. Get your timing right and get in the right asset class and cycles do your work for you. Or so it would seem.
Our sense is that right you have a lot of competing cycles. You have a historic low in interest rates across the globe. That led to a period when the cost of capital was incredibly cheap. This kick started an industrialised production boom in the developing world which has a momentum of its own. But is it sustainable?
You also have demographic and psychological and simple life cycles. As affluent Western investors get older, they seek to cash in on accumulated gains and enter into a golden retirement. Where will the money to move markets higher come from? An increase in mandatory superannuation contributions?
We’ll leave you today with a nearly incomprehensible chart that shows an even more intriguing longer-term cycle. The char appears to show that global energy production per capita has peaked and is headed for permanent decline…in other words…industrial civilisation has a lifespan of around 100 years…and we have reached that life span.
That would seem like bad news. Of course, perhaps post industrial civilisation will be a more pleasant place, albeit with fewer calories and no climate control. In all seriousness, though, if there is any truth to the idea that energy production per capita has peaked, it means China has picked a very bad time to have an energy-intensive industrial revolution. And to the extent Australia is now dependent on China for its prosperity, well the consequences are self-evident.
If the Credit Depression coincides with the Energy Depression, then you’d want to consider a very different financial survival strategy. More on that tomorrow.
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