Market History: Secular Cycles - Part 2
Hi, thanks for returning! I wrote about cycles last week and attempted to identify the secular cycles persisting since a century ago. Let's continue with our journey.
# 1940 - 1959 : Secular Bull Market
As US was drawn into World War 2, the US Federal government ran enormous deficits to fund the war against the Nazis in Europe and Japanese in Far East. Government spending % GDP rose to over 53% while debt % GDP exceeded over 110% during the war years. After the war, massive US investments and loans were made to re-build war-torn Europe and Japan. The war brought about rapid expansion to the sluggish US economy otherwise still in the throes of the Great Depression. Peace and prosperity returned for most Americans.
In an effort to free international trade and fund postwar reconstruction, nations began fixing their exchange rates by tying their currencies to the US dollar (Bretton Woods agreement) as the US government pledged a US dollar to 35 oz of gold bullion. The US dollar became a reserve currency for many nations and it began replacing the Sterling pound as the currency for international trade and commerce. The start of the Gold standard ushered in the golden age of the US dollar.
The end of WW2 also created heightend state of tension between the former Soviet Union and US as each fought for supremacy and over ideological differences. The fight against fascism and imperialism in WW2 had turned into a containment war against communism. This brought about the US invasion of Korea in the South in 1950 as fear escalated that Soviet Union would "export" communism to other Asian nations, following the fall of the Nationalist government in China to communist Mao.
Over this 2-decade period, corporate earnings rose strongly. Market EPS grew from $0.10 in 1940 to $0.35 by 1959 (3.5 times increase) buoying the S&P500 from 13 to 60 (4.6 times increase). US economy grew by 5 times over same period. This strong market performance, coupled with only shallow pullbacks, had all the makings of a secular bull market. This was the golden era for the US and Americans.
(a) World War 2 (1939-1945):
- Market declined 38% over 30 months
- Full recovery took 26 months
(b) Korean War (1950-1953):
- Market actually moved higher by over 20% during this period.
# 1960 - 1979 : Secular Bear Market
While the US economy continued to grow strongly over the following 2 decades, the world was plagued by regional conflicts (such as in Middle East and the Vietnam War) and significant turbulences in the world's economic system. President Kennedy was also assassinated in 1963.
Apart from the Cold War rivalry between the former Soviet Union and the US which culminated into an arms race and a race into space (US Apollo landing on the moon in 1969), the collapse of the Bretton Woods system in 1971 created huge market turmoil when the US dollar was offically de-linked from gold and exchange rates were allowed to float. This transition to a fiat currency and managed float system was rocky and characterized by plummeting stock prices, skyrocketing oil prices, bank failures and severe inflation. This set off a decline of the US dollar and appreciation of gold prices, reaching $800 an oz by 1979.
In the midst of these turbulences, Nasdaq opened in 1971 and a few important technological innovations were achieved in the US. ARPANET, a predecessor of the Internet we know today, was set up in 1969 by the US Department of Defense in partnership with four universities. The first desktop computer (Altair) was developed in 1974. A powerful technological revolution that was taking shape in the US eventually led to a multi-decade run-up in Nasdaq, reaching a high of 5000 points in 2000 from low of 55 in 1974 (a 90-fold increase over a 25-year period).
By end-1979, the US economy expanded by 4.9 times compared to where it was in 1960. Market EPS grew from $0.35 in 1960 to $1.50 by 1979 (4.3 times increase) but S&P was at around 140, just about 2.3 times higher than it was 20 years earlier. This period also witnessed 4 market corrections of at least 20%. This was a secular bear market for equities characterised by slower price growth, increased volatilities and more frequent and steeper corrections.
(a) Correction 1 (1962) - Cuban crisis
- Market dropped 28% over 3 months
- Full recovery over next 10 months
(b) Correction 2 (1966)
- Market dropped 21% over 8 months
- Full recovery over next 7 months
(c) Correction 3 (1969)
- Market dropped 35% over 17 months
- Full recovery over next 22 months
(d) Correction 4 (1973) - Oil crisis / Arab Oil Embargo / Nixon's resignation
- Market dropped 46% over 21 months
- Full recovery only 6 years later
Please tune in again next week.
We will conclude our market analysis and we will find out where we are now in the cycle and make an attempt to see where our future will head towards.
Sunday 29 April 2012
Sunday 22 April 2012
Market History: Secular Cycles - Part 1
Hi, welcome back. For this week and next, I will walk you through a brief journey back in time. A study on financial markets history is always instructive to understand how markets will behave.
Scientists are beginning to discover that the Universe manifests itself in countless observable cycles. From the smallest sub-atomic particles to the largest clusters of galaxies, they follow some kind of cyclic yin-yang order or rhythm. Likewise, societies progress, mature and decline before renewal sets off yet another cycle. What about the financial markets?
Prices may appear to move randomly, but with study show an underlying order and structure. Cycle analysis, Elliot waves, Kondratieve waves, Gann squares, angles, Fibonacci relationships and even postulations of planetary influences on financial markets are constructs and tools to help us uncover this underlying order. Psychologists and economists have also given a go at explaining the cycles of market boom and bust by attributing them to human behaviour through emotional cycles of extreme greed and fear, creating maximum energy at levels where turning points often happen. So, it seems, cycles are everywhere.
Recently, i purchased some data of the major US stock market indices over the past 100 years. When you have an opportunity to look at these vast amount of data plotted on a large chart, you will be amazed to see how the secular cycles (each lasting approximately 20 years) playing out in the stock market over the past century.
To many investors, the critical question is to know where we are now in the cycle so we can have some foreknowledge of what may be coming our way. Some call this forecasting.
In this and the next posting, I will share with you the secular cycles over the past century that I have identified from the charts. Whether to help you better prepare for the next looming crisis or just to pique your curiosity, I will outline the various crisis in each of these secular markets. I have also computed the exact magnitude the market moved and the time taken for a full recovery each time a crisis occured. You should find this information instructive. In each large secular cycle, there are usually one or more shorter counter-trend cycles.
So let's get started now! Back to the year 1906 we go.
# 1906-1919 : Reformative years
In the beginning of times, chaos reigned. Regulations and oversight in the financial markets were lacking and financial panics were rife. This was also the period where US continued to build on its industrial might having recently overtaken England as the world's largest economy. Ford Model T was introducted in 1908 and later that year, General Motors was formed. Technological feat led to the opening of the Panama Canal in 1914. War War 1 broke out later that year. The war actually accelerated growth for the US economy, bringing US GNP closer to $100 billion before the next decade arrived. The financial markets however remained flat over this period, as banking and currency reforms gradually took shape. Dow was at 110 points by end-1919, almost the same level as it was 13 years earlier.
(a) Panic of 1907:
- Market dropped 45% over 9 months.
- Full recovery 10 months later.
(b) World War 1 (1914-1918):
- Market gapped down 33% when it was re-opened after closure.
- Full recovery 9 months late, buoyed by growth from the war itself.
# 1920 - 1939 : Secular Bear Market
The 1920s was also known as the "Radio Age" where radio found its way into most American homes. This was also a dark age period for many Americans. The effects of Great Depression (1929) haunted the country for at least the next decade to come.
For the first 10 years during this secular bear market, the Dow actually rose from 110 points to almost 400 points. By 1929, with the onset of the Great Depression, the market not only gave back all its recent gains but turned into a steep loss. Such is the characteristic of a secular bear market where you expect to see wild swings and huge volatilities. The market collapse led to the formation of the Securities & Exchange Commission (SEC) in 1934. That year, Gold price was fixed at $35. By end-1939, Dow was back to a mere 150, closer to where it started two decades earlier. This was also a difficult time for the US economy. Its GNP recorded almost "zero" economic growth for a 20-year period. Literally, this secular bear market represented 2 lost decades for America and its people.
(a) Stock market crash of 1929:
- Market plunged 90% over 36 months.
- Full recovery took 25 years before Dow regained 400 points level.
Hope you had a fascinating read. Check in here again next week to find out where we are currently in the cycle and where we may go from here!
Hi, welcome back. For this week and next, I will walk you through a brief journey back in time. A study on financial markets history is always instructive to understand how markets will behave.
Scientists are beginning to discover that the Universe manifests itself in countless observable cycles. From the smallest sub-atomic particles to the largest clusters of galaxies, they follow some kind of cyclic yin-yang order or rhythm. Likewise, societies progress, mature and decline before renewal sets off yet another cycle. What about the financial markets?
Prices may appear to move randomly, but with study show an underlying order and structure. Cycle analysis, Elliot waves, Kondratieve waves, Gann squares, angles, Fibonacci relationships and even postulations of planetary influences on financial markets are constructs and tools to help us uncover this underlying order. Psychologists and economists have also given a go at explaining the cycles of market boom and bust by attributing them to human behaviour through emotional cycles of extreme greed and fear, creating maximum energy at levels where turning points often happen. So, it seems, cycles are everywhere.
Recently, i purchased some data of the major US stock market indices over the past 100 years. When you have an opportunity to look at these vast amount of data plotted on a large chart, you will be amazed to see how the secular cycles (each lasting approximately 20 years) playing out in the stock market over the past century.
To many investors, the critical question is to know where we are now in the cycle so we can have some foreknowledge of what may be coming our way. Some call this forecasting.
In this and the next posting, I will share with you the secular cycles over the past century that I have identified from the charts. Whether to help you better prepare for the next looming crisis or just to pique your curiosity, I will outline the various crisis in each of these secular markets. I have also computed the exact magnitude the market moved and the time taken for a full recovery each time a crisis occured. You should find this information instructive. In each large secular cycle, there are usually one or more shorter counter-trend cycles.
So let's get started now! Back to the year 1906 we go.
# 1906-1919 : Reformative years
In the beginning of times, chaos reigned. Regulations and oversight in the financial markets were lacking and financial panics were rife. This was also the period where US continued to build on its industrial might having recently overtaken England as the world's largest economy. Ford Model T was introducted in 1908 and later that year, General Motors was formed. Technological feat led to the opening of the Panama Canal in 1914. War War 1 broke out later that year. The war actually accelerated growth for the US economy, bringing US GNP closer to $100 billion before the next decade arrived. The financial markets however remained flat over this period, as banking and currency reforms gradually took shape. Dow was at 110 points by end-1919, almost the same level as it was 13 years earlier.
(a) Panic of 1907:
- Market dropped 45% over 9 months.
- Full recovery 10 months later.
(b) World War 1 (1914-1918):
- Market gapped down 33% when it was re-opened after closure.
- Full recovery 9 months late, buoyed by growth from the war itself.
# 1920 - 1939 : Secular Bear Market
The 1920s was also known as the "Radio Age" where radio found its way into most American homes. This was also a dark age period for many Americans. The effects of Great Depression (1929) haunted the country for at least the next decade to come.
For the first 10 years during this secular bear market, the Dow actually rose from 110 points to almost 400 points. By 1929, with the onset of the Great Depression, the market not only gave back all its recent gains but turned into a steep loss. Such is the characteristic of a secular bear market where you expect to see wild swings and huge volatilities. The market collapse led to the formation of the Securities & Exchange Commission (SEC) in 1934. That year, Gold price was fixed at $35. By end-1939, Dow was back to a mere 150, closer to where it started two decades earlier. This was also a difficult time for the US economy. Its GNP recorded almost "zero" economic growth for a 20-year period. Literally, this secular bear market represented 2 lost decades for America and its people.
(a) Stock market crash of 1929:
- Market plunged 90% over 36 months.
- Full recovery took 25 years before Dow regained 400 points level.
Hope you had a fascinating read. Check in here again next week to find out where we are currently in the cycle and where we may go from here!
Sunday 15 April 2012
Future of the US - Part 2
Hi, thanks for tuning in again. Let’s continue this week with the second and final instalment on what the next decade or two will behold for the US:
Remember to tune in next week and find out where we stand in a brief history of time!
Hi, thanks for tuning in again. Let’s continue this week with the second and final instalment on what the next decade or two will behold for the US:
5. Technological
Advancement. US will continue to
lead the world with its impressive prowess in innovation. Fast forward another
decade or two, new businesses in forms we never can imagine today will sprout
and transform the way we live and interact, just like how the internet, smartphones and
Facebook have changed the world. The new smart home of the future will spell an
entire new ecosystem of technological and lifestyle products that we can only
dream of today. Consequently, new business models will emerge rendering
existing business models obsolete, transforming industries, businesses and
commerce. US will be central to these pivotal changes. Medical advances of tomorrow will make serious diseases a thing of the
past. Imagine someone diagnosed with cancer could just walk across the street
to GNC or Wal-Mart to purchase over the counter cancer pills for treatment and
in a week’s time, the cancer is eradicated, just like flu. Breakthrough in
genetics, life sciences, pharmaceuticals and medical robotics will remain the
domain of US supremacy in the next decade and two. Advancement in industrial engineering, agricultural
technology and recycling capabilities will not only lift US economic
productivity but will also contribute to sustainable long-term growth for the
world as world population expands and continues to demand clean water, food and
other resources adding continuous strains to our planet. The world will
progress as the US innovates and exports high
value-added products and services to the world, in process expanding its own economy.
6. Energy
and the US dollar. Domestic US oil production will rise from 5.6 million
barrels a day to 9.1 million by 2015, bringing about a leap in share of
domestic oil production to consumption from 28% to 46% of the total 20 million
barrels consumed by the US in a day. An extra 3.5 million barrels per day works
out to $134 billion a year at current prices. This will drop US trade deficit
by nearly 25% over next 3 years, a hugely positive for the US dollar.
Breakthrough in technologies such as “fracking” will potentially help US to recover over 100
years’ of supply of natural gas. This can potentially replace coal and even oil
when the technology is perfected in the coming decade. Power plant
conversion from coal to natural gas is already accelerating at a dramatic pace,
leaving China as remaining coal buyer in time to come. Many drivers will also disappear from gasoline pumps as electric cars become the norm. Advancement in
industrial manufacturing processes and nanotechnology will create new breakthrough
in products that are less polluting and require less petrochemicals to make. All these will have a
significant impact on oil and coal prices in the coming decade or two as supply
increases and demand reduces. As US becomes less dependent on foreign oil, US
balance of payments will significantly improve as it switches from a net
importer of oil to a net exporter. Eliminating its largest import while adding
an important export will be hugely positive for the US dollar. At $100 oil
today, it was estimated that 30-40% of that comes from a fear premium that oil
supplies are disrupted. A strong US dollar and reduced reliance on foreign oil
import will help keep a lid on global runaway inflation in the coming decade. This will be a boon for corporate profits.
7. Onshoring.
Over the recent decades, US companies sought elsewhere to relocate their plants
to places with lower wages, where unions and regulations are lacking and where
there is a paucity of environmental controls. They opened plants in Singapore,
Taiwan, Malaysia and more recently, in Mexico, Thailand and China. An estimate places the
number of jobs lost in the US at 25 million from offshoring in the past decade
alone. How long will this continue unabated? After 30 years of offshoring and
falling real American wages and soaring Chinese wages, offshoring may not be
that great a deal anymore for US companies. In 1977, average Chinese labourer
earned about $100 a year. Today it is $3,500 and for the trained technicians,
it is somewhere near $24,000 per annum, with total compensation rising 20
percent a year. At this rate, US and Chinese wages will reach parity in about
10 years. Offshoring also carries many risks.
Asian countries still lack infrastructure. Natural disasters like earthquakes, fires,
tidal waves can disrupt a highly tuned, incredibly complex manufacturing
system. Not to mention political risks in the host countries and occasional hiccups in the relationship between US and China over trade and other issues that may
disrupt commerce. Fast forward a decade or two, 20-30% of jobs lost to offshoring
could return to the US. This could amount to 8 million jobs, cutting US
employment rate by half, at least (by current unemployment numbers). This may
add another $60 billion in GDP per year, boosting GDP growth by at least 0.5%
per year. Onshoring will then lead to a stronger US dollar, rising stocks and
lower bond prices.
8. Improving
fiscal position. As the US economic engine resumes its growth in the
longer-term, the macro backdrop as outlined here will help US reduce
its budget deficit. US goods and services such as education continue to be sought after everywhere. Reforms on medi-care and retirement age issues will have
taken place then. As the world hopefully becomes safer through globalisation, it will
become cheaper for the US to stay friendly than blowing someone else up. The US
may cut its defence spending, triggering a global dis-armament race. Hundreds of billions saved annually from
reduced defence spending will help US to significantly narrow its budget
deficit, improving its fiscal position and strength as a world economic superpower.
The world continues to move in phases, to the tune of the yin-yang
interplay. The difficult times confronting the US today will give way to a more
prosperous period ushering in the next golden era in the coming decade or two.
The banking system collapse and bailout, deleveraging taking place across
individuals and businesses, aging population, industries hollowing out from the
country through offshoring, corporate America flushed with cash now but unwilling to invest due to
uncertainties, high unemployment rate, huge budget deficit and a weakening US
dollar may dominate today’s headlines but will in time fade into distant memory
as US moves on to the next boom phase from the current bust.
If US GDP were to reclaim the 4% annual growth rate as seen in the
1990s, stock markets will resume a secular bull trend (by definition, lasting a 20 year
period). Dow may climb to 20,000 by 2020. After that, anything like a fourfold
increase seen during the Clinton administration, may propel the Dow to 80,000 on the back of a strong US economy and an expanding global economy bolstered by a growing world population.
American capitalism will regain its footing. Americans are
positive, its society values innovation and free choices. These are America’s
great strengths that make it a resilient and vibrant nation waiting to usher in
her next golden era in the coming decades.
Next week, I will share with you some interesting research I have done
looking at the oscillating cycles in the financial markets over the last 100
years. The capitalist boom and bust cycles manifest like the cyclic yin-yang. All things and all societies move in phases of growth, maturity and decline and the cycle will eventually repeat. We are in a secular bear market today.
When will the next light shine on us? Remember to tune in next week and find out where we stand in a brief history of time!
Sunday 8 April 2012
Future of the US - Part 1
After writing about China, I thought I should talk about the US this week as these two nations will collectively shape the century to come. This posting will be the first of two I will write on the US, with the second instalment coming next week.
Prior to the 19th century, China boasted the world’s largest economy for most part of history till it was overtaken by England in early 1800s. England rose on the back of her successful Industrial Revolution which started in 1760 as well as her colonialist ambitions. By 1890, US overtook England as the world's largest economy and has since enjoyed a pre-eminent status as the world's sole surviving superpower. In 2000, China entered the WTO and the world’s manufacturing bases decidedly shifted from US, Mexico, Europe and other Asian nations to China.
After writing about China, I thought I should talk about the US this week as these two nations will collectively shape the century to come. This posting will be the first of two I will write on the US, with the second instalment coming next week.
Prior to the 19th century, China boasted the world’s largest economy for most part of history till it was overtaken by England in early 1800s. England rose on the back of her successful Industrial Revolution which started in 1760 as well as her colonialist ambitions. By 1890, US overtook England as the world's largest economy and has since enjoyed a pre-eminent status as the world's sole surviving superpower. In 2000, China entered the WTO and the world’s manufacturing bases decidedly shifted from US, Mexico, Europe and other Asian nations to China.
Since then, the US
economy continued to grow, but has done so at a slower pace in real terms than a
decade earlier. Is this spelling the beginning of the end to US supremacy with the ascension of China? The
US is already beleaguered by its own domestic problems and a huge budget
deficit that effectively bankrupted its government. As superpowers rise and
fall, will this new century’s power axis tilt and shift eastwards, relegating US to an inconsequential player on world affairs?
Despite many headwinds confronting the US today, we need
to bear in mind the world does not move in a linear fashion. The natural law of yin-yang dictates the cyclic phases every society has to go through. The American society will likewise go through phases of prosperity, decline and a resumption of growth.
Fast forward a decade or two, you may once again see the US on the growth path. As the pendulum swings again, a new golden age may be awaiting Americans, and by extension for rest
of the world since US will likely continue to be a net importer from the world
and the world's largest economy after China.
A golden age may play out in the US because of shifts in demographics,
economic and trade structures as well as advancement in technologies over
coming decade or two. US greatest strengths have been innovations and freedom. These will help US stay resilient and re-invent itself as a new phase of prosperity emerge.
1.
Retiring
population. One reason for the slowdown in the US in the coming decade
is because 80 million baby boomers will be retiring followed by only 65 million Generation X-ers entering the workforce. Some
21% of 310 million Americans today are in retirement, and is expected to grow
to 48% in 20 years’ time. More Americans in retirement mode means fewer buyers
for real estate, home appliances and risky assets like equities. Instead, in the
coming decade, there will be more relative demand for health care, assisted
living facilities and safer assets like bonds. Slower economic growth, higher
budget deficits (more resources being re-directed to support long lived senior
citizens) and a weak currency are guaranteed outcomes for now and the coming
decade at least. How then will a golden era emerge in the US?
2. US housing
outlook. Retiring baby boomers are no longer purchasing additional
properties. Many are looking at selling their homes as they raise cash for
retirement. This supply glut will not be absorbed by enough Gen-Xers leading to
a significant slowdown in construction activities in the US for the coming decade. Home prices may
stabilise now but will remain low for most of the coming decade. Fast forward
another decade or two, the US real-estate will look bright once again. After years of contraction in construction and as more Gen-Xers invest in properties, a
scarcity in housing will result and this will set off the next real-estate and construction boom, underpinning the start of the next golden age for Americans.
3.
US wage
outlook. The currently slowing US economy, together with the negative effects
of globalisation, has brought down real wages in the US. Standard of living for
the middle class will continue on a declining path. As US adjusts to the new
structural role it will play in the new world economy, innovations in
technology, life sciences, genetics, medical sciences, industrial applications, aeronautics and electronic
commerce will create new growth focus and opportunities for Americans. US
will continue to lead the world in
innovation. To supplement natural population growth rates, US must ensure the
right immigration policies are discerning enough to target and attract talented
foreigners into these critical fields without depressing local wages across the
board. As US continues to lead the world in expanding these strategic, value-added
industries, it will continue to expand the global economic pie and its own
share of this prosperity. As the baby boomers eventually exit the workforce,
there will be labour shortages in the US that will once again lead to wage
hikes and growing opportunities for the working Americans. The standard of
living for the middle class will then reverse a two decade decline.
4.
Return of
the US consumers. Today, private
consumption accounts for about 80 percent of US GDP. A slowdown in real wages
will mean a weakening in spending power. But with a weak housing market and
little interests to invest in large big-ticket purchases such as houses or
cars, Americans borrow less and they end up with more disposable income. I
believe this explains why retail sector is currently booming despite talk about the death
of the US consumers. Consumers end up splurging more on smaller-ticket
purchases like smartphones, jewellery and accessories. In a decade’s time,
higher consumer consumption will spread to all sectors as housing market recovers and
Americans also start to trade their old automobiles for more fuel efficient cars.
The US economy will grow at a more robust 4% like it did in the 1990s.
Stay tuned next week, as there are more
reasons to believe how the world will change in the coming decade or two that will underpin America’s economic might ushering in her next golden era.
Sunday 1 April 2012
Future of China
Despite China's strong GDP growth relative to the West, its equity markets are likely to remain weak with downside bias. This is despite the Chinese government reversing its contractionary monetary policies to fight inflation as well as its readiness to deploy stimulus measures to keep the economy growing so as to provide continued employment for its massive population. Why then are the equity markets in the West rallying even with anemic economic growth while the Chinese equity markets are sliding as its economy expands?
A few concerns play out here:
1. Banking System under stress. China's economic and banking reforms slowed after it successfully cleaned up its state banks' balance sheets and launched their IPOs to strengthen their capital structure. The boom years of 2006, 2007 further lightened pressure on pace of reforms (complicated by bureaucraftic turf battles) as focus turned to the impact of an appreciating renminbi on exports instead. By 2008, at the onset of the financial crisis, it became concerned with how the global economic slowdown will impact on China exports. Given its huge production capacity and workforce, China may face massive unemployment and instability (especially a sizeable migrant population lives in its big cities, estimated at over 300 million). China then embarked on a massive stimulus program (relative to GDP, it far exceeded the bailout in the US) that forced banks to aggressively lend once again - just a few years after cleaning up their balance sheets. While this helped prop up the economy, this also led to much economic waste on financing un-economic projects and directly creating a real-estate bubble. Banks in the heat of lending could not perform proper due-diligence and they are now again riddled with assets of dubious quality. The concerns in the stability of its banking system and its ability to weather through an asset bubble burst are bearish enough for the equity markets.
2. Slower economic growth. With Eurozone likely to impact on China's growth in the near-term, Chinese government will be concerned about how best to further stimulate the economy without worsening the asset bubble as it has to keep a tight reign on food, energy and housing prices affecting many ordinary Chinese. Managing demand-side economics through stimulation of consumer domestic consumption will require time. Though the Chinese government is in a strong fiscal position to embark on aggressive expansionary policies, given the constraints outlined here, China may have to settle for a slower growth rate (7% region instead of 9%) as being sustainable for the country. Slower economic growth translates to slower earnings growth for companies in China, which will likely translate to lower stock prices ahead.
3. Limited liquidity participation from overseas. Over the past 3 years, much liquidity remained in the US system because it is still the "safest and most liquid" market to invest, despite its ballooning budget deficits and rating agency downgrades. The low interest rate environment and record high bond prices brought about by the US Quantitative Easing altered the risk-reward attractiveness for the US equity markets. Consequently, a US equity bull market ensued, surprising many. While there were some funds which did flow out of US in search of "higher growth elsewhere", they went largely to commodity and oil producing/exporting countries rather than to China (China also has capital controls). Australia, Canada, Mexico, Brazil, Malaysia, Indonesia, India and Russia benefited when funds flowed out of the US markets, but China did not. Capital controls in China effectively limited meaningful foreign participation in its markets and devoided its markets liquidity coming from overseas.
4. Fewer domestic growth opportunities. China, with its leninist-style Government and centrally-planned economic model, may be more responsive to a crisis, as shown in 2008. Today, there are plans to develop mega-cities in China as well as building more airports, rails and highways. However, longer-term, two factors will contribute to slowing economic growth for China. One is aging population exacerbated by its "one child only" policy and the other is the already substantial infrastructural build-up compared to other emerging countries like India. As economic growth plateau, so will corporate earnings and stock prices in the longer-term.
5. Lack of investor confidence. Investors are also concerned about the quality of earnings reported by corporate China. China is aggressively pushing for adopting GAAP accounting standards in its own PRC accounting codes. This will take time. Meanwhile, more accounting fraud continue to be uncovered. Quality of earnings is suspect. With SOEs consisting a large part of overall market capitalisation, private investors could be rightly concerned about the sustainability of corporate earnings growth independent of government support or participation. All these impact on investor confidence in Chinese companies and equities.
6. Alternative investments and reduced liquidity in equity markets. Consequently, Chinese would prefer to park their investible cash in real-estate or other forms of exotic investments like antiques, paintings, vintage wine and coin collections. Gold, as a store of value during inflationary times, is also diverting liquidity away from equity markets. With tightening economic policies of past years, and the reigning in on SOE, businesses and individuals taking borrowed money from banks to speculate in the stock and property markets, another important source of liquidity and leverage in the equity markets have been removed. This, together with competing asset classes for investible funds, have exerted further pressure on the Chinese equity markets, which have also been operating at a much higher PE than Western markets.
China is a huge and complex country to manage. Navigating through the headwinds has its difficulties and challenges. China has a long history, its feudalistic mindset is deeply entrenched. Decades of centrally planned economy also added bureaucratic complexity. These pose definite challenges to necessary reforms ahead. But the resilience, determination and commitment of the Chinese people and its government to modernise China and propel it into the forefront shaping the new world order will be China's great strength.
The global economy will expand as world population grows and technology and innovation will continue to help boost productivity, boost living standards and sustain an ever larger world population living on limited resources. China understands this must be the best time for it to re-invent itself for the new century. The collective leadership in Beijing knows reforms are needed and they must not miss such a golden opportunity to re-establish China's rightful place on the world stage. The future for China is bright. It will weather the headwinds and eventually cruise in a safer plane on to much greater heights.
Despite China's strong GDP growth relative to the West, its equity markets are likely to remain weak with downside bias. This is despite the Chinese government reversing its contractionary monetary policies to fight inflation as well as its readiness to deploy stimulus measures to keep the economy growing so as to provide continued employment for its massive population. Why then are the equity markets in the West rallying even with anemic economic growth while the Chinese equity markets are sliding as its economy expands?
A few concerns play out here:
1. Banking System under stress. China's economic and banking reforms slowed after it successfully cleaned up its state banks' balance sheets and launched their IPOs to strengthen their capital structure. The boom years of 2006, 2007 further lightened pressure on pace of reforms (complicated by bureaucraftic turf battles) as focus turned to the impact of an appreciating renminbi on exports instead. By 2008, at the onset of the financial crisis, it became concerned with how the global economic slowdown will impact on China exports. Given its huge production capacity and workforce, China may face massive unemployment and instability (especially a sizeable migrant population lives in its big cities, estimated at over 300 million). China then embarked on a massive stimulus program (relative to GDP, it far exceeded the bailout in the US) that forced banks to aggressively lend once again - just a few years after cleaning up their balance sheets. While this helped prop up the economy, this also led to much economic waste on financing un-economic projects and directly creating a real-estate bubble. Banks in the heat of lending could not perform proper due-diligence and they are now again riddled with assets of dubious quality. The concerns in the stability of its banking system and its ability to weather through an asset bubble burst are bearish enough for the equity markets.
2. Slower economic growth. With Eurozone likely to impact on China's growth in the near-term, Chinese government will be concerned about how best to further stimulate the economy without worsening the asset bubble as it has to keep a tight reign on food, energy and housing prices affecting many ordinary Chinese. Managing demand-side economics through stimulation of consumer domestic consumption will require time. Though the Chinese government is in a strong fiscal position to embark on aggressive expansionary policies, given the constraints outlined here, China may have to settle for a slower growth rate (7% region instead of 9%) as being sustainable for the country. Slower economic growth translates to slower earnings growth for companies in China, which will likely translate to lower stock prices ahead.
3. Limited liquidity participation from overseas. Over the past 3 years, much liquidity remained in the US system because it is still the "safest and most liquid" market to invest, despite its ballooning budget deficits and rating agency downgrades. The low interest rate environment and record high bond prices brought about by the US Quantitative Easing altered the risk-reward attractiveness for the US equity markets. Consequently, a US equity bull market ensued, surprising many. While there were some funds which did flow out of US in search of "higher growth elsewhere", they went largely to commodity and oil producing/exporting countries rather than to China (China also has capital controls). Australia, Canada, Mexico, Brazil, Malaysia, Indonesia, India and Russia benefited when funds flowed out of the US markets, but China did not. Capital controls in China effectively limited meaningful foreign participation in its markets and devoided its markets liquidity coming from overseas.
4. Fewer domestic growth opportunities. China, with its leninist-style Government and centrally-planned economic model, may be more responsive to a crisis, as shown in 2008. Today, there are plans to develop mega-cities in China as well as building more airports, rails and highways. However, longer-term, two factors will contribute to slowing economic growth for China. One is aging population exacerbated by its "one child only" policy and the other is the already substantial infrastructural build-up compared to other emerging countries like India. As economic growth plateau, so will corporate earnings and stock prices in the longer-term.
5. Lack of investor confidence. Investors are also concerned about the quality of earnings reported by corporate China. China is aggressively pushing for adopting GAAP accounting standards in its own PRC accounting codes. This will take time. Meanwhile, more accounting fraud continue to be uncovered. Quality of earnings is suspect. With SOEs consisting a large part of overall market capitalisation, private investors could be rightly concerned about the sustainability of corporate earnings growth independent of government support or participation. All these impact on investor confidence in Chinese companies and equities.
6. Alternative investments and reduced liquidity in equity markets. Consequently, Chinese would prefer to park their investible cash in real-estate or other forms of exotic investments like antiques, paintings, vintage wine and coin collections. Gold, as a store of value during inflationary times, is also diverting liquidity away from equity markets. With tightening economic policies of past years, and the reigning in on SOE, businesses and individuals taking borrowed money from banks to speculate in the stock and property markets, another important source of liquidity and leverage in the equity markets have been removed. This, together with competing asset classes for investible funds, have exerted further pressure on the Chinese equity markets, which have also been operating at a much higher PE than Western markets.
China is a huge and complex country to manage. Navigating through the headwinds has its difficulties and challenges. China has a long history, its feudalistic mindset is deeply entrenched. Decades of centrally planned economy also added bureaucratic complexity. These pose definite challenges to necessary reforms ahead. But the resilience, determination and commitment of the Chinese people and its government to modernise China and propel it into the forefront shaping the new world order will be China's great strength.
The global economy will expand as world population grows and technology and innovation will continue to help boost productivity, boost living standards and sustain an ever larger world population living on limited resources. China understands this must be the best time for it to re-invent itself for the new century. The collective leadership in Beijing knows reforms are needed and they must not miss such a golden opportunity to re-establish China's rightful place on the world stage. The future for China is bright. It will weather the headwinds and eventually cruise in a safer plane on to much greater heights.
My return from China
My first post will be on China.
Having just returned from there managing an enterprise of over 4,000 employees across 33 Chinese cities, I had travelled to countless places and met scores of people from various walks of life (finance, business and government). From the high-ranking officials, businessmen to the ordinary Chinese like the porter and my chauffeur, they have extended their friendships and valuable insights that shaped my understanding of China today.
China continues to fascinate, in part because it remains a mystery to many outside the country. It has the potential, the will-power and every right to reclaim its rightful place in the new world order, yet it has its own challenges and uniqueness to manage and cope with.
I am not writing a travelogue. The focus here is sharing with you what goes on in my mind whenever I am asked about investing in China.
My first post will be on China.
Having just returned from there managing an enterprise of over 4,000 employees across 33 Chinese cities, I had travelled to countless places and met scores of people from various walks of life (finance, business and government). From the high-ranking officials, businessmen to the ordinary Chinese like the porter and my chauffeur, they have extended their friendships and valuable insights that shaped my understanding of China today.
China continues to fascinate, in part because it remains a mystery to many outside the country. It has the potential, the will-power and every right to reclaim its rightful place in the new world order, yet it has its own challenges and uniqueness to manage and cope with.
I am not writing a travelogue. The focus here is sharing with you what goes on in my mind whenever I am asked about investing in China.
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