Everyone is on bubble watch nowadays, me included, as central banks flood their respective countries with mountains of money. While the US has done a ton of printing of dollars it is often overlooked that the Chinese have also printed a ton of Yuan as well. While there are definite differences in the economies of the US and China, we could argue those difference all day long, the one thing we could all agree on is that China a lot of flaws in its system. I would counter by saying their flaws are probably pretty severe, but no worse than the US.
Regardless, I have been reading a lot about the bubble in China, especially in their real estate prices. I do not doubt that as property values have gone parabolic in the country, some areas make the peak price increases in the US look like pathetic in comparison, but is it the same bubble that the US had? The answer is, no one really knows for sure because the data is spotty at best. My guess is that the price bubble is probably worse than the US, but I am willing to bet that mortgage fraud, home equity loans, securitization and the host of other issues that basically collapsed the world economy are not the same, at all.
So, at the end of the day, we will see a price collapse in China which will lead banks to have losses on their books, but it will end there. It will likely be as bad as the early 1990’s in the US banking system compared to the 2008 collapse that the US had and it will more than likely not spread globally like the US credit collapse did. However, it is problematic for the world to have the second, it surely has beat out Japan by now, largest economy approach a huge bubble so early in its quest for world domination, especially when it is the manufacturing center of the world.
If the bubble pops, which it will, it will take capital to fix which means that money will not be loaned out to manufacturers. When that happens the cost of capital will increase driving up prices which means your trip to Walmart will not be as cheap as it once was, especially if Washington forces the Chinese to strengthen its Yuan as well. That will be a problem for us and the rest of the world as China led the world out of the recession, if you believe it is actually over that is, so if China contracts it will lead the world right back into a recession, or make the one we are in even worse.
It is just interesting that Americans always assume that everyone acts like they do and spend all of their money. The Chinese are fanatical savers and it is highly unlikely that they would leverage their home, i.e. home equity loans or lines of credit, to buy junk they simply do not need like Americans do. I remember when Lay’s potato chips were trying to make headway into China and one women interviewed said why would I spend that kind of money on that when the same money can buy me potatoes for a month? That is their mentality and they do not spend what we do not have and pay for it later like what we do, that is what I admire about their culture. This is why if or when the bubble pops it will be a major problem, but nothing like what we saw here or in Europe.
With that in mind I am not crazy about investing in China because I believe that the bubble will pop and it will slow their growth down dramatically. Depending how the government handles the issue it could be a nonevent or a huge problem with, believe it or not, political instability. Plus, so much money has flowed into China through BRIC’s it is kind of crazy to keep money there right now. I am way more interested in India and Russia than China and Brazil, but all emerging markets have me a bit nervous because when everyone agrees that is where you should be, well, you know, do the opposite. Regardless, I believe the bubble will pop, but before the China bubble pops the US equity bubble will pop first.
This is not just my opinion, but that of Deutsche Bank Chief Economist Norbert Walter. He brings his concerns to an interview to CNBC.com and he has very strong, reasonable concerns for his comments. I am on the same page as he is and have brought my concerns over the economy and the dollar to my readers for a long time now. This, in my opinion, merely ads credibility to my opinion and throws aside the thought of those green shoots we hear so much about.
If things were fine then we would have seen some real action from the Fed today, certainly if things were as fine as CNBC and other media outlets claims it is at least. Regardless Mr. Walter went on to say; “I believe that the rescue packages brought on have been so costly for so many governments that the exit from this fiscal policy will be very painful, very painful indeed,” he said. “Some of us are already talking about a W-shaped recovery. I’d probably talk about a triple-U-shaped recovery because there are so many stumbling blocks here to get out of this.”
This sounds pretty familiar to me as it is the same concerns I have echoed for some time now. However, I am not so bleak in my outlook and expect a W recovery and pray that we do not have a triple U pattern, which is possible, but, hopefully, unlikely. He went on to say that many companies thought the recession was going to be shallow and did not layoff people even as sales deteriorated, but that will change in the near future, according to Mr. Walter.
He also has concerns over Australia’s potential interest rate increase in September, which is possible, and says the “markets will certainly shiver” if that happens. He, as I, also has concerns over the dollar as the current administration wrestles with health care and has put an exit strategy on the backburner of the Fed’s monetary stimulus. The Fed’s actions will only increase our troubles as cheap money got us here in the first place, but now we have so much more to worry about than cheap money like the monetization of our debt and the printing of more dollars.
Mr. Walter went on to say; “there are big concerns of about the direction of the U.S. dollar.” Followed by; “I’m deeply worried about the worries of those investors who have invested a lot, really a lot into the dollar” like the Chinese, Japanese, Arabs and Russians, he said. All of those countries, with the exception of Japan, have voiced some concerns over the safety of the dollar. Their concerns are with merit, I might add, as we are issuing more debt and have monetized a lot of our debt and I am sure that will continue after October.
He concluded with these comments; “If they have second thoughts about the quality of this currency then the dollar is bound to weaken” which means higher long-term interest rates for a country where government debt is approaching 100 percent of gross domestic product, he said.
If that happens, “2010 could be a worrisome year for all of us,” he said.
These comments are echoing my concerns, but they are even darker than I thought is possible. This is why I have always allocated more of my money to non US securities, usually keeping only 20-25% in the US and the rest invested internationally, mostly Asia. I have also taken great pain to find other alternatives such as precious metals, GLD and SLV are OK, but physical metals never hurt, and sovereign government debt, like the PCY which I have talked about a lot.
Regardless, these are not just my opinion and we should look at what Mr. Walter is saying with an open mind. While it is unlikely that we will have a doomsday scenario, like a currency crisis, but it certainly does not mean that things will not get very bad. This is why I believe in hedging and others should as well, but I digress.
We did not test the lows of Friday, October 10th, but based on the selloff yesterday and the decline in the Asian markets it looks like the testing of the lows will be tomorrow. Currently the Asian-Pacific markets are down 2 to 6% with the Nikkei leading the selloff.
This thing is not over, but we need to hit the lows before the recovery starts. Even after the lows are reached the 1% or higher daily swings will not stop. Volatility will remain high for months as the market reacts to new lows and economic data. We avoided a complete meltdown in the banking sector, but that risk is mitigated now.
That is good news for us, but the market needs to capitulate to stop the constant 5% daily drops. Unfortunately, this means a one day 10 – 20% or more declines in equities, on top of the 38% loss we have already. Yes, this is a tough pill to swallow, but it needs to happen. Buy on extreme weakness, greater than negative 3% daily drops, and be cautious on strength and unload loosing positions or weaker holdings.
Continue dollar cost averaging, carefully. We are not out of the woods yet, but some companies are trading at great prices with high yields. Buy strong balance sheet firms and consumer cyclical as they should hold up under selling pressure and a recession which could last 2 years.
Oil traded down big time which is in part due to a stronger dollar, but also because world demand is declining rapidly. Gold has lost its luster at the moment, but it looks somewhat attractive at the moment. The good news is treasuries, the longer term maturities, are seeing some strength which was not there a week ago, while this is a sign of flight to quality it does represent confidence in the government and should help keep foreign dollars in the dollar, which we need right now.
Be careful and cautious. We have been calling this market pretty well, but if we are right this will turn very bad in the short-term.
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