Investors live in hope. They know that on balance, and over time, things go well. Economies grow. Living standards improve. People live longer. And shares rise in value.
It’s right that we should be optimistic. But there are also times, such as now, when it’s right to be cautious, even pessimistic… for a while.
David Fuller says markets are driven by sentiment and liquidity.
Sentiment has improved somewhat recently as things look better for the global economy (cheaper oil and other commodities) and for the dollar. The only credible major alternative to the greenback, the euro, has been hurt by the prospect of recession in Europe and lack of confidence in the way the authorities are dealing with it.
However, the improvement in sentiment is fragile. The downside potential in commodities is limited because of fundamental shortages. America’s foreign trade deficit may be easing, but remains serious and fundamental, with a high dependence on imported oil. And on foreign investors to finance it.
Political risks are rising with growing protectionism, the prospect of a leftist presidency in the US, the threat of war in the Mideast, a resurgent imperialism in Russia, and instability in emerging economies as voters react angrily to high food and fuel costs.
As for liquidity… the Anglophone world is in the grip of a credit crunch that seems destined to continue for years as financial institutions “take to book” the losses inherent in their dodgy assets, seek new capital, and shift to increasingly conservative lending policies.
When you look at the charts, it’s hard to find support for the current wave of cautious optimism.
In equities, the US looks as if it’s experiencing nothing more than a classical bear market rally, Europe looks very bearish, and so does China. Only in Tokyo does it look as if the worst may be over – but that can’t be said with any certainty.
In currencies the rally in the dollar is unconvincing. The euro looks as if it will resume its upsurge later this year. The yen remains in a tightly-managed bear trend in terms of both those.
However, the interesting contrast is between the currencies of the two major nations China and Britain.
China’s renminbi is strong. Although a managed currency, its strength accurately reflects the power of its underlying economy. By contrast, the weakness of sterling reflects Britain’s dire situation.
When the tide goes out, as Warren Buffett said, you can see who’s been swimming naked. The Brits now realize how incompetent, self-serving and irresponsible has been Gordon Brown’s long reign, so the UK faces global slowdown bereft of the resources and room for manoeuvre to deal with it.
One key indicator is how heavily the nation has borrowed to support lifestyles, the property boom and government profligacy. At last count the average UK family debt, at 178 per cent of annual household income, was not only the highest in the world’ s seven most developed economies, but also the highest ratio any country in that group has ever known.
Residential mortgage debt per head is higher in Britain than in the US, while the foreign trade deficit is also relatively greater — equivalent to 5 per cent of GDP. No country has ever run a deficit at that level without a following fall of at least 30 per cent in its exchange rate, according to analysts at the investment house Bedlam.
Of all major currencies, sterling is the one whose prospects make me most nervous.
If sterling’s decline so far is no surprise to those of us who watch such things, the dreadful performance of China’s stock markets over the past year certainly has been. And with no sign of a bottom in sight.
An American analyst suggests that the 100 million individual investors have made capital losses of RMB5 trillion — that’s about $750 billion, or the equivalent of about three years’ average wages per investor — over the past 12 months.
Chinese shares seem to be reacting to the prospect of economic slowdown as the government applies the brakes to contain inflation, infrastructural constraints such as power shortages and congested transport systems bite, and energy and food prices raise costs.
Profits are evaporating as slackening export markets impact on enterprises, especially the many that traditionally operate with tight margins. In the Pearl River Delta, China’s “new Ruhr,” 10 per cent of businesses owned from Hong Kong are expected to close down this year.
Why I’m optimistic about China
Yet, unlike other economies, China has immense resources available to stimulate domestic demand, with a high savings ratio, nearly $2 trillion in foreign reserves, and strong state finances. The national debt, for example, is only 16 per cent of GDP, compared to 75 per cent in India.
There are already many signs that Beijing will act with determination to offset slowing or contracting export markets, to keep on creating the 20 million extra jobs needed every year, and to build the infrastructure required if China is to regain its historic status as the world’s biggest economy.
The government is expected soon to approve a stimulatory package of RMB 370 billion (about $55 billion) of extra state spending and tax cuts. That’s in addition to the RMB1 trillion ($150 billion) on reconstruction after the Sichuan earthquake. About as much is being spent every year on infrastructure such as power stations, waterways, roads and ports.
China’s investment in energy supply alone is breathtaking. It’s switching on an average two new coal-fired power stations every week. And it plans massive expansion of atomic power. BHP Billiton’s chief Marius Kloppers says China plans mass-production of standard-model nuclear units that will generate power “40 per cent cheaper than anyone else.”
It seems to me that when the Chinese stock markets do bottom, they could be the buy of the century. We should use this quiescent period in investment markets to plan our strategy what to invest in when the signals flash green.
By Martin Spring in On Target, a private newsletter on global strategy