The battle lines for 2014 are forming more clearly now. For example, the Nikkei 225 fell by 2.35% overnight. The developed world (the US and Europe) may be optimistic about growth this year. But there are plenty of concerns about Japan and China. How much funny money is it going to take to pump stocks and GDP higher? Janet Yellen has been confirmed by the US Senate to head the Federal Reserve. She will take command of an army of money printers with a will to dominate markets.
We’ll get back to that in a moment. But after yesterday’s Markets and Money, we sat back and thought long and hard about the challenges you face this year. It became clear what we have to do in this space every day: win the battle of ideas about how to keep your money safe and make more of it. That may mean conducting a rear-guard guerrilla action against the progressive corporatists/fascists who’ve taken over the world’s financial system, and exposing them for the frauds and charlatans that they are.
It’s not going to be easy. But really, as we said, the underlying objective is to protect and grow your money. It’s hard to do that these days when the very definitions of money and capitalism seem to be changing. Take, for instance, the debate about quantitative easing we brought up yesterday.
Yesterday we made the point that QE is a hollow, superficial explanation for why stocks should go up in 2014. There is no grand business or economic vision behind the argument, no real business case for why earnings will grow with QE. That’s because – barring financial companies who benefit from low borrowing costs – most businesses don’t experience any improvement to earnings from QE.
In fact, according to Thomson-Reuters, 108 companies have given fourth quarter earnings outlooks that are below Wall Street analyst’s expectations. Analyst John Butters at FactSet says that of the 107 companies on the S&P 500 that have provided earnings guidance for the fourth quarter, 94 of them warned that earnings will be lower than consensus estimates.
Now, there could be a bit of play acting here. It’s always better to low-ball the estimate and then deliver a ‘surprise’ positive result. The only thing better than an earnings surprise is a snake surprise. But it could be that the people operating businesses have a better insight into whether QE helps earnings than Wall Street analysts.
The more you examine the idea, the more you realise it’s an empty shell masquerading as a serious argument. There’s nothing to it. You can’t increase sales for a business by lowering interest rates. You can, of course, engineer a temporary boost to profitability by lowering interest costs on borrowed money. But most of this benefit must surely be priced into stocks by now.
Then again, maybe there doesn’t have to be anything substantial to QE for it to work. If stocks are going higher because the Fed’s buying bonds, then maybe the path of least resistance for you is to quit asking questions and buy stocks. It worked for everyone last year. Why can’t it work again this year?
The old timey value investor will tell you that when you stop worrying about the value of a security and speculate only on the price, you’re going to overpay. The price you pay matters, in other words. And when the whole professional investment community throws in the towel on valuing securities because it doesn’t seem to give you an advantage, then you’re usually near an absurd top in markets.
By the way, according to Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE), stocks are clearly overvalued. Shiller’s ratio divides equity prices by a 10-year average of earnings. It gives a long-term picture of the current value (or lack thereof) in the market. The historic average is around 16. The current average is around 25.4.
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Shiller himself says that given the momentum in the market, the ratio could go to 35 and the market wouldn’t have to automatically crash. But he’s not comfortable with the idea of buying stocks on this basis. You have to choose between sitting out on a possible 40% rally in stocks, or buying in and hoping that, well, this time it really is different.
Not a great choice, is it? With the internet boom, you at least had the claim that digital technology was changing the world. The information revolution would create brand new businesses and make investors rich. It was an exciting and somewhat-believable narrative.
In a roundabout, way, the information revolution has changed the world. It was a technology revolution. But technology is inherently deflationary. It tends to lower labour costs, for one thing. And the makers of technological appliances – after a brief and glorious period of profits when everything is new – face the inevitable commodification of production.
You could ignore all that in 1998 and 1999 when technology and internet companies were just start-ups with glossy prospectuses and vacuous business plans. But by 2000, it was clear that many internet companies were just vehicles for making investment banks and insiders rich. There would never be any profits for shareholders because there would never be any profits.
This, by the way, is a point our mates Kris Sayce and Sam Volkering make at Revolutionary Tech Investor. Plenty of technologies are revolutionary. But unless you find an entrepreneur who can turn an innovation into a real business, then the story means nothing to investors. It has to be a technology or an idea you can build a viable business model around, and then it requires competent people to execute the plan.
QE, by contrast, requires no thinking or competence. It requires blind faith in the Fed. That’s it. If you can manage to stop thinking and start following, you have a good chance at making money, at least for a while.
We’ll come back to this little front in our war against the Fed tomorrow. But let’s quickly look at another front that matters a lot more to Australian investors: China. HSBC’s China’s Purchasing Managers Index (PMI) fell to 50.7 in December. That was still a positive reading, but down from 52.5 in November.
The bigger concern, for Australians anyway, is that China’s central government can tolerate lower annual GDP growth if it means reigning in local government debt raised through the shadow banking system. The ‘shadow banking system,’ by the way, simply refers to non-regulated financial firms or lending outside the traditional banking system.
The People’s Bank of China – probably trying to reduce the liability it would face in bailing out local governments that default on their debt – is looking at measures to reduce lending and improve transparency in China’s financial system. Local government debt has increased by over 67% from the end of 2010, according to a report out last week by China’s national audit office. It grew from 10.7 trillion yuan at the end of 2010 to 17.9 trillion yuan in June of last year.
It’s the banking crisis that nobody in Australia wants China to have. If you’re achieving growth through speculative borrowing and lending, the growth isn’t going to last. That’s what’s at stake for Australia in 2014; that China doesn’t grow at 7% but something more like 4%.
China’s total debt-to-GDP ratio was 87% in 2008. It’s now 218%. That shows you how leveraged the current boom is. The government wants to deleverage the economy slowly, safely, and methodically. That’s another big battle for 2014.
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