Posts tagged ‘Chinese economy’

The Bungee Market

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 1, 2015). Subscribe on the right side of the page for the complete text.

Are you an adrenaline junkie? You may be one and not even know it. If you are an investor in the stock market, you may have noticed a sinking feeling in your investment portfolio before a sharp bounce-back, much like a bungee jump. Before the recent drop of -6.6% in the Dow during August, some stock investors got lulled into a state of complacency, considering a tripling in stock prices over the last six years.

Almost any current or future news headline has the capability of potentially triggering a short-term bungee jump in stock prices. Now, worries over the health of the Chinese economy and financial markets, coupled with concerns of an impending rate hike by the Federal Reserve have created some tension for global financial markets. The slowdown in China should not be ignored, but as famed investor Bill Nygren pointed out, its impact should be placed in the proper context. China only represents 15% of global economic activity and U.S. exports to China only account for 0.7% of our GDP.

Although the drop in U.S. prices last month was scary, other major markets were in deeper freefall. For example, the Chinese Shanghai Composite, Japanese Nikkei, and German DAX indexes nosedived -15%, -10%, and -9% last month, respectively.
Successful veteran investors understand alarming volatility is the price of admission to achieve superior, long-term equity returns. In fact, data compiled since 1900 underscores the commonplace of volatility over the decades. For example, during the last 115 years, investors have witnessed the following:
  • 5% market corrections, 3 times per year on average (“correction” = price decline);
  • 10% market corrections, 1 time per year on average; and
  • 20% market corrections, 1 time every 3.5 years on average.
The chart below provides some graphical perspective on volatility over a shorter period of time (i.e., the last six years). As you can see, previous corrections have felt just as uncomfortable in magnitude as the latest dip, but regardless of the endless stream of concerns, prices have repeatedly rebounded.

Welcome Back Volatility! Mini Flash Crash

Another byproduct of the recent downdraft was unusual trading activity in certain stocks and exchange traded funds (ETF). For example, during the first ten minutes of trading last Monday, blue chip companies like General Electric Co (GE) and Starbucks Corp (SBUX) fell by more than -20%, before snapping back by at least +20% by the end of the day. Trading in certain exchange traded funds (ETFs) experienced similar trading anomalies, including Vanguard’s Consumer Staples ETF (VDC) with approximately $2.4 billion in assets. After dropping -32% in the opening minutes of the trading day, VDC closed down a modest -3%.
This type of trading activity does not build a lot of short term investor confidence, but this phenomenon of volatility is nothing new. As I pointed out in my Catching Falling Knives article, we survived quite nicely in the subsequent years post the 2010 “Flash Crash” – thank you for the +36% surge in the S&P 500 index through mid-2011. And if the -588 point drop (-3.6%) last Monday felt horribly for you, the decline actually isn’t that bad if you consider how miserably the -22.6% drop felt for investors on October 19, 1987 (“Black Monday“). That’s right, about one quarter of the entire stock market’s value was wiped away within a 24 hour period. You can see below, “Black Monday” turned out to be a very temporary condition that represented a huge buying opportunity. The Dow Jones Industrial Average has since increased in value by more than 10-fold (1,000%+) since the price crash of 1987 bottomed out.
Surprise, Surprise? No!
Should these sporadic wild short-term swings come as a surprise to anyone? Given the explosion in the number of daily shares exchanging hands, thanks in large part to cutting-edge advancements in networking technology, it’s no wonder we don’t experience these problems more frequently. Over the last five trading days, the U.S. stock market has averaged 10,676,130,293 shares in daily trading volume (see table below). With a computerized tidal wave of panic and greed periodically circulating through the financial markets in nanoseconds, investors will need to become more accustomed to turbulences like the recent one because technology will continue to push the envelope on ever-increasing trading speeds and volumes. Technological glitches played a major role in 1987 on “Black Monday” when computers were overloaded by panicked selling related to derivative trading (portfolio insurance). Similar problems occurred during the “Flash Crash” in the spring of 2010 when dislocations were created by the fragmented number of exchanges and under-regulated high frequency trading (HFT) participants.
If you read the newspaper, watched the evening news, or combed financial blogs, you probably wouldn’t have any difficulty finding any items to worry about on the negative side of the ledger, including China’s difficulties, timing of a Fed Funds interest rate increase, and generally sluggish global economic growth. After last month’s bungee dive in stock prices, much of the underlying positives have been neglected or ignored:
  • Economic growth revised higher (Q2 GDP raised to +3.7% from +2.3%)
  • Unemployment rate continues to drop ( at 5.3%, a 7-year low)
  • Interest rates near historic lows (3.95%, 30-year mortgage rate), which will remain massively stimulative even if the Fed modestly increases short-term rates
  • U.S. corporate profits are near record highs (despite dampening effect of the strong U.S. dollar on exports)
  • Reasonable valuations (improved after latest index price declines)
  • Housing market on a steady recovery (existing home sales at multi-year highs and pricing up +6% vs. July of last year)
  • Massively accommodative central banks around the globe (e.g., European Central Bank and People’s Bank of China)
Not everyone wants to go bungee jumping, and not all investors can stomach the adrenaline filled swings of a 100% stock portfolio asset allocation. It’s volatile times like these that remind investors about the importance of diversification, along with staying true to your investment objectives. Too many times investors use their emotions to guide decision making. Living through market drops can be scary, but if your investment plan is securely in place, you can rest assured that this financial bungee ride will eventually bounce back higher.

investment-questions-border

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in GE and certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in SBUX, VDC, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

September 5, 2015 at 10:00 am Leave a comment

Investors Take a Vacation

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (August 3, 2015). Subscribe on the right side of the page for the complete text.

It’s summertime and the stock market has taken a vacation, and it’s unclear when prices will return from a seven month break. It may seem like a calm sunset walk along the beach now that Greek worries have temporarily subsided, but concerns have shifted to an impending Federal Reserve interest rate hike, declining commodity prices, and a Chinese stock market crash, which could lead to a painful sunburn.

If you think about it, stock investors have basically been on unpaid vacation since the beginning of the year, with the Dow Jones Industrial Index (17,690) down -0.7% for 2015 and the S&P 500 (2,104) up + 2.2% over the same time period (see chart below). Despite mixed results for the year, all three main stock indexes rebounded in July (including the tech-heavy NASDAQ +2.8% for the month) after posting negative returns in June. Overall for 2015, sector performance has been muddled. There has been plenty of sunshine on the Healthcare sector (+11.7%), but Energy stocks have been stuck in the doldrums (-13.4%), over the same timeframe.

Source: Yahoo! Finance

Chinese Investors Suffer Heat Stroke

Despite gains for U.S. stocks in July, the overheated Chinese stock marketcaused some heat stroke for global investors with the Shanghai Composite index posting its worst one month loss (-15%) in six years, wiping out about $4 trillion in market value. Before coming back down to earth, the Chinese stock market inflated by more than +150% from 2014.

Driving the speculative fervor were an unprecedented opening of 12 million monthly accounts during spring, according to Steven Rattner, a seasoned financier, investor, and a New York Times journalist. Margin accounts operate much like a credit card for individuals, which allowed these investors to aggressively gamble on the China market upswing, but during the downdraft investors were forced to sell stocks to generate proceeds for outstanding loan repayments. It’s estimated that 25% of these investors only have an elementary education and a significant number of them are illiterate. Further exacerbating the sell-off were Chinese regulators artificially intervening by halting trading in about 500 companies on the Shanghai and Shenzhen exchanges last Friday, equivalent to approximately 18% of all listings.

Although China, as the second largest economy on the globe, is much more economically important than a country like Greece, recent events should be placed into proper context. For starters, as you can see from the chart below, the Chinese stock market is no stranger to volatility. According to Fundstrat Global Advisors, the Shanghai composite index has experienced 10 bear markets over the last 25 years, and the recent downdraft doesn’t compare to the roughly -75% decline we saw in 2007-2008. Moreover, there is no strong correlation between the Chinese stock market. Only 15% of Chinese households own stocks, or measured differently, only 6% of household assets are held in stocks, says economic-consulting firm IHS Global Insight. More important than the question, “What will happen to the Chinese stock market?,” is the question,  “What will happen to the Chinese stock economy?,” which has been on a perennial slowdown of late. Nevertheless, China has a 7%+ economic growth rate and the highest savings rate of any major country, both factors for which the U.S. economy would kill.

Source: Yardeni.com

Don’t Take a Financial Planning Vacation

While the financial markets continue to bounce around and interest rates oscillate based on guesswork of a Federal Reserve interest rate hike in September, many families are now returning from vacations, or squeezing one in before the back-to-school period. The sad but true fact is many Americans spend more time planning their family vacation than they do planning for their financial futures. Unfortunately, individuals cannot afford to take a vacation from their investment and financial planning. At the risk of stating the obvious, planning for retirement will have a much more profound impact on your future years than a well-planned trip to Hawaii or the Bahamas.

We live in an instant gratification society where “spend now, save later” is a mantra followed by many. There’s nothing wrong with splurging on a vacation, and to maintain sanity and family cohesion it is almost a necessity. However, this objective does not have to come at the expense of compromising financial responsibility – or in other words spending within your means. Investing is a lot like consistent dieting and exercising…it’s easy to understand, but difficult to sustainably execute. Vacations, on the other hand, are easy to understand, and easy to execute, especially if you have a credit card with an available balance.

It’s never too late to work on your financial planning muscle. As I discuss in a previous article (Getting to Your Number) , one of the first key steps is to calculate an annual budget relative to your income, so one can somewhat accurately determine how much money can be saved/invested for retirement. Circumstances always change, but having a base-case scenario will help determine whether your retirement goals are achievable. If expectations are overly optimistic, spending cuts, revenue enhancing adjustments, and/or retirement date changes can still be made.

When it comes to the stock market, there are never a shortage of concerns. Today, worries include a Greek eurozone exit (“Grexit”); decelerating China economic growth and a declining Chinese stock market; and the viability of Donald’s Trump’s presidential campaign (or lack thereof). While it may be true that stock prices are on a temporary vacation, your financial and investment planning strategies cannot afford to go on vacation.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 3, 2015 at 10:51 am Leave a comment

China: The Trade of the Century?

So it goes, Britain was the country of the 19th century, the United States was the country of the 20th century, and China will be the country of the 21st century. Is investment in China hype or reality? Here are some points in China’s favor:

  • Large Labor Force: With a  population exceeding 1.3 billion people, China has plenty of labor available to expand GDP (Gross Domestic Product).
  •  No Nonsense Government: An authoritarian government has its advantages. While pornography (see article) and unrest may be problems, infrastructure projects are not.
  • Education: Chinese culture values education. As a result, China is slowly shifting away from its roots as the globe’s manufacturing and piracy capital. Intellectual property is appreciated more now that China is becoming a leader in emerging technology areas, such as solar power.
  • Trade Surplus & Currency Reserves: Must be nice to have trade surpluses and massive currency reserves (~$2.3 trillion). This is what happens when you are in a position to export more than you import.
  • Manageable Debt: China’s Debt/GDP ratio is less than 25%. You can compare that to the U.S. at around 100% and Japan at over 200%. Disciplined fiscal management provides the Chinese government with more options in dealing with the global slowdown (e.g., stimulus).
  • Long Runway of Growth (Read More):  China’s long runway of growth has allowed it, and should continue to allow it, to grow at above average growth rates – in the 3rd quarter of 2009 the Chinese economy grew at a very healthy +8.9% rate.

With all these positives, it’s no wonder China is the darling of the world. Given the constructive outlook, how can investors take advantage of the Far East opportunity in China?  Our good friend at Investing Caffeine (figuratively speaking), Burton Malkiel (Princeton Professor of Economics and Chief Investment Officer at AlphaShares), is bullish about China and is sharing his preferred participation method…an all-cap China exchange traded fund (ticker: YAO)  – Read more about Malkiel and Active vs. Passive Investing (12/8/09 Post).

Just how bullish is Professor Malkiel?

I think China will continue to have the highest growth rate of any major country in the world, and within 20 years, China will be the world’s leading economic power.”

 

And he puts his money where his mouth is. Last year the professor shared his Chinese exposure in his personal portfolio:

“My portfolio is probably 20 percent Chinese, and that includes not only indices but also individual companies.”

 

Risks: The Price to Play

Professor Malkiel is not blindly diving into China – he researched the markets for years before taking the plunge. In an article from last year (From Wall Street to the Great Wall), he highlighted some of the inherent risks:

1) Foreign Neighbors:  China continues to have tense, although cordial, relations with some of its neighbors like Taiwan and Japan. Their dealings are stable now, but the future is uncertain.

2) Social Unrest: An uneven distribution of income can lead to serious social unrest, especially in the rural parts of the country. If the government can’t keep the economy humming along, those left behind may fight back.

3) Environmental Degradation: China is building nuclear, wind, and solar projects at a frenetic pace, but China is also the globe’s largest emitter of greenhouse gases (relies on dirty coal for 70% of its energy), according to CNN. If China becomes an irresponsible power hog, there could be damaging effects to the economy.

4) Corruption: This continues to be a problem, but Malkiel points out the case of Zheng Xiaoyu, a former director of China’s FDA (Food and Drug Administration) equivalent. In 2007, he was executed after being found guilty of taking bribes.

5) Banking System:  Malkiel notes that China continues to have a fragile banking system with a lot of bad loans. Due to political reasons, certain government owned entities may receive risky loans in the name of creating jobs – even if it means keeping unhealthy zombie banks alive.

Trading Strategies:

Beyond investing in AlphaShare ETFs (YAO), Malkiel advocates considering the other options, such as the “A”, “H”, and “N” shares. Unfortunately, the more inefficient “A” shares, which trade in Shanghai and Shenzen, are largely unavailable to investors outside of China. However, the “H” shares and “N” shares are available to international investors. “H” shares are listed on the Hong Kong Stock Exchange and the listed companies follow globally accepted accounting principles. The “N” shares come from companies registering with the SEC (Securities and Exchange Commission) and trade either on the NYSE (New York Stock Exchange) or NASDAQ exchanges.

 Lastly, Malkiel knows he is not the only investor to pick-up on the China growth story. Multinationals are investing heavily in China, and these domestically based companies can serve as indirect investment vehicles to benefit from the attractive fundamentals as well.

Professor Malkiel calls China the “growth story of the world.” Simple math shows us that this Asian juggernaut (the third largest country in the world by GDP) will soon pass Japan in the number two position and the U.S. is likely only a few decades ahead after that.  Having explored and studied China firsthand, I concur with many of Malkiels conclusions, which opens the possibility that China could reasonably be the top country (and top trade) of the 21st century?

Full Malkiel Article: From Wall Street to the Great Wall – Investment Opportunities in China

Read More Regarding YAO

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, like FXI, at the time of publishing. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

December 9, 2009 at 1:45 am 4 comments


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