January 15th, 2010
Quote of the Week
Professor Jay Ritter of the University of Florida is the author of one such study ranging over a hundred years of data from sixteen different countries. His conclusion is clear:
“Countries with high growth potential do not offer good investment opportunities unless valuations are low.”
Dear Members,
The European Central Bank (ECB) has left its main interest rate unchanged at the record low of 1 percent for an eighth successive month.
The decision, which was expected by financial markets, confirmed that monetary policy is steady as the Euro-zone’s economic recovery remains fragile and inflation is undershooting the central bank’s target. Economists think the main policy rate could remain at 1 percent until at least the end of the year.
Australia (EWA) recorded an unexpected drop in unemployment in December as the country’s economy generated triple the number of jobs economists had forecast.
Unemployment fell to 5.5 per cent, down from a revised 5.6 per cent in November, with the fall largely attributed to a surge in part-time employment. The Australian dollar (FXA is on our ETFfocus List) rose on the data as economists forecast that the country’s central bank would next month raise interest rates following three successive monthly increases at the end of last year.
Australia’s population is rising but the economy’s expansion is more than absorbing the larger workforce. Jobs are being created in a variety of industries, including the mining, energy, and retail sectors which are among the country’s biggest employers.
Emerging market government bonds (EMB) have collectively gained investment grade status for the first time in spite of investorworries over risk of future sovereign defaults. The upgrade in Turkey (TUR) by Moody’s put the index over the top.
The average rating of the 39 countries that make up the benchmark emerging market sovereign bond index has moved up one notch from junk, or high yield, to the lowest rung of investment grade, according to Moody’s.
A controversial and potentially ground-breaking proposal by Chinese authorities to allow mainland citizens to buy shares listed in Hong Kong has been formally tabled.
The State Administration of Foreign Exchange better known as SAFE, a body under the central bank which first announced plan in August 2007, said in a strange statement the proposal was one of 19 documents that were no longer valid because they had expired. This announcement has hit Hong Kong (EWH) this week as it was banking on increased flows from mainland investors.
According to the World Economic Forum, “a hard economic landing for China, fiscal crises in developed countries, and broad asset-price collapses are the biggest risks to global stability this year and beyond.” China is one of the biggest concerns in this year’s Global Risk Report, partly because of the way it has responded to the global financial crisis and partly because it is one of the only risks yet to be realized from those consistently identified in the report’s five-year history.
The report has been successful in identifying the big risks in the past few years, having flagged up in 2006-2008 asset-price overvaluations, consumer over-indebtedness, oil and food price jumps and the destabilizing impact of the US current account deficit.
This year’s report says the chances of a serious economic slowdown in China are above 20 percent and would lead to economic losses of between $250bn and $1,000bn. The repercussions would be greater than this because of the country’s central role in areas such as funding developed country deficits and consuming the majority of exports from other south-east Asian countries (EPP). Imagine the impact on a country like Australia (EWA).
The authors of the report said that while China appeared to have navigated the global financial crisis well, it had relied on especially high credit growth to do this, which risked inflating asset price bubbles and unbalanced growth.
Commercial lending by Chinese banks grew more than 45 percent between July 2008 and July 2009, according to data from Swiss Re. “China is on a very unbalanced path of economic growth,” said Daniel Hofmann, group chief economist at Zurich Financial Services, the global insurance group.
Housing price appreciation in China increased its pace in December, climbing 7.8 percent from the same month a year earlier and prompting new government measures as Beijing attempts to slow soaring prices without derailing the economic recovery.
Average prices in 70 large and medium-sized cities across the country rose 1.5 per cent from November, the National Development and Reform Commission said on Thursday.
In response this week, the People’s Bank of China raised the amount banks must set aside in reserves, in an attempt to cool an overheating economy. But it raised fears among some investors that it would result in reduced demand for resources and possibly slow trade flows.
This led to many Asian currencies retreating from highs. The Korean won has gained nearly 4 per cent to a 15-month high since the start of the new year, making it the top performer among nine emerging Asian countries.
Since the Shanghai Stock Exchange was founded in 1990, Chinese investors have only been able to bet on stock prices going in one direction: up. That is set to change, however, as the government has approved long-awaited reforms that will allow traders to profit from falling as well as rising markets.
On Friday, the China Securities Regulatory Commission said the State Council, or cabinet, had authorized a trial period for short selling and margin trading as well as the launch of stock index futures in the domestic A share market.
On the security side, China says it has tested an advanced missile interception system in a move that serves as a reminder of the rapidly progressing technological upgrade of its military capabilities.
A one-sentence statement via Xinhua, the official news agency, said only that the country had “tested a mid-course missile interception technology on domestic territory,” that the launch met its expected objective, was defensive in nature and not aimed at any country.
The test is expected to strain relations with Washington again at a time when there has been growing criticism from Beijing against arms sales by the US to Taiwan. Last week, the US defense department announced it had awarded a contract for advanced Patriot Pac-3 anti-missile equipment destined for Taiwan to Lockheed Martin.
In response, Beijing released a series of warnings and demands for the US to stop weapons sales to the self-ruled island that China claims as part of its territory.
Weapons experts said Beijing’s strong reaction over what they called a minor step was unusual.
“The real issue is the surprising noise this contract announcement has generated from Beijing, as they have already acted out their displeasure on this sale with the suspension of military-to-military exchanges last year,” said Rupert Hammond-Chambers, the president of the US-Taiwan Business Council, a lobby group. “The Chinese recognize the vacuum Mr. Obama has created with another long delay in notifications – namely the Black Hawks [helicopters], remaining Pac-3s and several smaller deals – and see it as weakness.”
China’s demographic conundrum is getting more press these days. According to the UNPD’s projections, China’s 65-plus age group currently numbers around 110 million. Over the coming generation, this group is set to rise to 280 million — growing at a pace of almost 3.8% per annum. By 2035, nearly one in five Chinese will be 65 or older, constituting a staggering 280 million senior citizens. The aging situation is likely to be even more acute in the Chinese countryside due to the ongoing migration of younger, rural-born workers to towns and cities.
According to the projections of a team of demographers led by Professor Zeng Yi of Peking University, China’s rural areas are probably already grayer than its cities—and the difference will grow starker every year. Prof. Zeng’s team projects that by 2035 over one in four rural residents would be 65 or older. In comparison, the 65 plus age group in Japan is currently at 20%.
China seems to be incrementally becoming less hospitable to foreign companies; not that it was easy to make money or protect intellectual property at any time. One example is that China has sought to strengthen its domestic encryption industry while withholding the government certification that foreign-owned encryption companies in China need to sell their products to many users.
Jörg Wuttke, president of the European Chamber of Commerce, said that no E.U. companies had pulled out of China yet. But the encryption dispute would be the most likely cause if any did in the near future, he said.
Duncan Clark, the chairman of BDA, a Beijing consulting firm that advises major telecommunications and technology companies, said that Google’s difficulties were indicative of broader troubles for foreign companies in China.
“There has been a raft of decisions and unpredictability, a kind of unpleasantness about what’s happening here,” Mr. Clark said. “There has been this received wisdom that no one can afford not to be in China, but that is being questioned now — there’s kind of an arrogance that’s characterizing government policy toward multinationals.”
You may notice that our weekly ETF Pick of the Week has changed to a monthly basis. Part of the reason is that members seem to prefer less picks but more ammunition behind them. From my perspective less picks allows me more flexibility. The last thing you want as members is for me to make a pick just to stay on weekly schedule.
This month’s pick as explained below is the inverse ETF to FXI. FXI has been in a near-term downtrend since mid-November. In fact, for nearly the last 2 months, FXI has been on a course of hitting lower lows.
Finally, Peter Tasker of Arcus Research in Tokyo writes this about current China valuations in the Financial Times:
So are valuations low enough in the emerging markets to offer good investment opportunities? In less popular areas, perhaps yes. But the biggest of them all, China, is in a bubble phase. At its 2007 peak, the Shanghai A-share index traded at over 7 times book value, far above the 5 times reached by Japan’s Nikkei Index at its peak twenty years ago.
Having subsequently halved, Chinese stocks are no longer quite so expensive. However the adjusted “Graham-and-Dodds” price-to-earnings ratio – a time-tested indicator of value which uses an average of ten years earnings – remains at a dizzying 50 times. Compare that with around 15 times in the US, itself by no means cheap in historical terms.
Residential real estate appears to be even more overvalued. In bubble-era Japan, a byword for manic real estate speculation, apartment prices peaked out at 12 to 15 times average household income. In major Chinese cities, the multiple is currently 15 to 20 times. Asset market bubbles of any scale and duration usually have their equivalents in the real economy. The biggest distortion in the Chinese economy is the explosion in fixed asset investment to an eye-popping 50 per cent of GDP. By comparison, Japan in its miracle decade clocked up economic growth rates similar to China’s today by investing between 30 and 35 per cent of its GDP.”
Best regards,
Carl T. Delfeld |
