Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Monday, 3 September 2012

What does September bode? Part - III



Continued...

3. China will save us.

This is the most bizarre hope in my opinion. I’d made the case earlier (Red Flags Over China) about how futile it is to hope that a centrally-planned economy built on exports and marked by extreme wealth inequality where a large proportion of the population is still dirt-poor is suddenly going to turn around and rescue the west by becoming a broad-based consumer-led economy.

Since a lot of the facts have already been pointed out in the 1st August post referred above, I’ll stick to the new evidence which has come to light since then.

Facts:

  1. The latest Chinese PMIs, both official and HSBC, inject a dose of pessimism. HSBC China manufacturing PMI stated: “Manufacturing sector operating conditions worsened at the sharpest rate in 41 months”. The official PMI slid to a nine-month low of 49.2. Graphs 1 & 2 below.
Graph 1: HSBC China Manufacturing PMI
Source: HSBC, Markit

Graph 2: Comparison of Official and HSBC China Manufacturing PMIs

  1. The Shanghai Composite is below the level it reached in February 2009 (Graph 3). If the economic prospects are so rosy then why aren’t the locals piling in?
Graph 3: Shanghai Composite
Source: Yahoo Finance

  1. After many predictions of a vertical rise in steel consumption, the Chinese steel industry is coming down with a bad post-stimulus hangover. Iron-ore prices have already crashed through the once unassailable $110/tonne level. Now the ripple effect of bad loans on bank books has started.
  2. Such excess may be the reason why Chinese leaders have been restrained in unleashing another round of stimulus.
  3. Further complicating matters is the foreign currency outflow out of China which is automatically creating a contractionary monetary policy. Though for the time being, PBoC still has room to manoeuvre and neutralise this effect.
Verdict:

The hope that Chinese demand will save us, failing which a Chinese stimulus will surely save us is false. The Chinese economy will not experience an immaculate transformation into a consumption-led economy from an investment and export-led one. Bulls in China shop may find they are liable for damages. Therefore, commodities and economies dependent on them and China (eg. Australia) are in a precarious position. 

A word of caution for investors before they plunge in

Even though the market’s hopes for a miracle may be in vain and policy actions may have only a fleeting effect, we must remember Keynes dictum that the market can be irrational for longer than one can be solvent. Just as faith in squiggly and straight lines often makes a technical analyst’s predictions self-fulfilling, similarly faith in the omnipotence of central bankers and policymakers can cause markets to run away from fundamentals. Moreover, the well-flagged dangers of September may have already caused the faint-hearted to flee. A rally will cause them to return for fear of missing out and hence reinforce itself. Since the crisis began in 2007 there have been many periods of such "astonishing" rallies in various markets. However, fundamentals always reassert themselves and bigger the rally, harder the subsequent correction.

The suitably positioned long-term investor can weather the irrationality while the short-term speculator must tread carefully. Paraphrasing Mark Twain, ‘September: This is one of the peculiarly dangerous months to speculate in markets. The others are July, January, October, April, November, May, March, June, December, August, and February.’

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