Courtesy of Doug Short.
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I often write about investment opportunities – or (sometimes) the lack thereof – here in the U.S. But of course, my portfolios usually include some foreign investment opportunities as well (sometimes more than others).
So today, let’s look at the largest country in the world – which happens to be involved in a lot of stories in the financial press these days.
China
Here’s a table showing how China compares with the U.S. in selected categories:
Numbers are approximate. GDP figures are adjusted for Purchasing Power Parity (PPP). Data compiled from the International Monetary Fund (IMF), USDebtClock.org, countryeconomy.com, and the 2014 Index of Economic Freedom report by the Heritage Foundation (in partnership with the WSJ).
China is increasingly becoming one of the most important drivers of global markets. In the good ol’ days, investors often said, “When the U.S. sneezes, the rest of the world catches cold.” While the U.S. still has that effect, now China often does as well.
On Monday, when the Dow Jones dropped about 107 points, MarketWatch and others blamed the decline (in part) on these 2 issues related to China:
- First, China’s Finance Minister Lou Jiwei said the government would not provide immediate stimulus to counteract some weakening economic reports.
- Second, Wall Street was “worried” that some Chinese economic data due to be reported after U.S. stock exchanges closed for the evening might reveal further weakness.
Oh… and a little stock named Alibaba (NYSE: BABA) lost 4.3% of its value that day as well. I’m sure you’ve heard more than enough about that; but just in case you’re not current on the topic, every single non-institutional BABA investor has lost money on the IPO so far… perhaps barring some fortunate folks who may have received a sweetheart deal from their broker.
Still, when the aforementioned economic data came in slightly better than expected on Monday evening, the Wall Street Journal’s “Macro Horizons” blog reported this:
“The improvement wasn’t dramatic, but it was enough for investors to breathe a collective sigh of relief.”
The article went on to say this:
“(China’s) continued growth could depend on how much of a stimulus effort the government is willing to undertake.”
Yikes!
Challenges
While challenges (or crises) often create opportunities, sometimes challenges just present… well, challenges (at least, for a while, until markets are able to fully discount the prevailing risks).
China has more than its fair share of fresh challenges today. Whether or not these challenges have yet created attractive opportunities for investors remains to be seen. The Shanghai stock market remains more than 30% below its March 9, 2009, level. The U.S. stock market, by contrast, is almost 200% above its levels on that same date, which happens to be the low point of the global crash (data from Doug Short at dshort.com). In terms of finding something attractive that you can “buy low,” perhaps China is a candidate for that. But here are some of the challenges:
First and foremost, China is still a Communist country. The state’s knee-jerk reaction is still to intervene, control, and direct from the central government level – even though leaders profess to be interested in fundamental reforms.
China’s economic data is reported by the government, and is suspect. For example, discrepancies are rampant about how fast (or slow) China’s economy is growing. “Official” (government) reports continue to be in the 7-8% range. Many analysts, however, calculate that China’s growth is no better than U.S. growth, in the 2-3% range (as reported in this recent Forbes article by Gordon Chang).
The Heritage Foundation report says that in China, “institutionalized cronyism remains pervasive,” among other non-flattering things. Heritage doesn’t spare the U.S. its share of harsh words, saying, “The growth of government has been accompanied by increasing cronyism that has undermined the rule of law and perceptions of fairness…. The U.S. is the only country to have recorded a loss of economic freedom each of the past seven years.” (emphasis added)
Much of China’s growth in recent decades has resulted from government infrastructure spending, rather than being led by Chinese consumers. The world seems to be waiting with bated breath to see if & when Chinese consumers will finally propel the country’s economy into the stratosphere. (Note: it doesn’t seem to be happening yet. Even Jack Ma of Alibaba has said he believes his company must expand outside of China in order to deliver growth).
As noted, many experts believe more government stimulus is needed. On the other hand, many (including your humble author) worry that any stimulus by the Chinese government would merely retard the ability of China’s economy to stand on its own two feet. China’s officials say they want to gradually pursue reforms, but the question is whether the country’s central planners will have the fortitude – even in the midst of a slowing economy – to make the shift from command-and-control to free markets.
Property values in China have recently been dropping like a rock. Forbes columnist and The Coming Collapse of China author Gordon Chang recently wrote that confidence in Chinese property values is “gone.” Chang reports that prices in many areas have plunged 30% in the last year, and that “the drop-off would have been greater… had not government enterprises made about 40% of the purchases.” Chang quotes an analyst who said the government intervention had the feel of a “bailout.”
Finally, here’s one more insight about whether Chinese stocks might look like an attractive opportunity to buy low. I mentioned earlier that the Shanghai market is down about -30% from 5 ½ years ago, compared to a roughly +200% rise for the S&P 500 here in the U.S. That statistic makes China seem like a bargain. But if you measure from January 2000 (near the peak of the stock market bubble), China’s market is about +65% higher than it was then, compared to about +35% for the U.S. Again, you can see this data – along with some great charts – on Doug Short’s website.
As I said, the challenges investors face when dealing with anything related to China are not insignificant.
China and the U.S.
Our economy is linked in many ways to the rest of the world, including China, which is becoming one of the most critical participants in the global financial system.
China is on track to surpass the U.S. as the world’s largest economy in the next 10-15 years, if not sooner.
China holds more U.S. Treasury bonds than any other foreign country (although China has recently reduced its U.S. bond holdings slightly… giving us a reminder that China holds great power over the interest rates the U.S. Treasury will have to pay on its debt going forward).
China is the 3rd largest destination for U.S. exports.
China is the world’s largest oil importer and uses more coal than the rest of the world combined.
China buys more gold than any other country.
China habitually tries to keep its currency’s value low when compared to U.S. dollars, in order to keep China’s exports relatively inexpensive around the world.
China has recently displayed interest and intent in minimizing its use of U.S. dollars. Since 1974, oil has traded in U.S. dollars around the globe. China has recently struck agreements with Russia and Brazil to conduct trade – including oil – using their own currencies. Japan and Australia also have “currency swaps and other arrangements” in place with China to circumvent the U.S. dollar, according to Addison Wiggin at The Daily Reckoning. China apparently sees little or no need to use the U.S. dollar in its transactions, which may seem logical, but as investors, we must be aware this emerging trend represents a vast departure from a 40-year practice around the world. If the shift continues (as it likely will), it could lead to a significant revaluation of the dollar around the world. The 1974 advent of the “petrodollar” system has provided a “prop” for the value of the dollar worldwide, as countries have had to use dollars in order to buy oil. I’m sure James Rickards’ book (The Death of Money) will have much more to say about this before I finish reading it – including whether China would even “care” if the U.S. dollar crashes.
China’s military and cyberspace ambitions remain somewhat mysterious, although both represent significant concerns for U.S. national security scholars. Ian Bremmer, a political risk consultant, told the New York Times in March 2014 that he views China as a greater threat to U.S. allies than Russia, “and by a very large margin.” One concern is that China has lately been threatening to expand itself geographically, taking new island territory in the South and East China Seas. Some of those islands are controlled by Japan, and the U.S. would be obligated by treaty to defend Japan against China in the event of conflict.
China’s foreign policy seems to be somewhat isolationist, although China has historically allied itself to varying degrees with such dubious actors as Russia, Syria, Venezuela, and even Iran and North Korea.
What to do
For now, the risks are significant. As always, I believe (and my portfolios reflect) that you need to protect the vast majority of your assets in a Retirement War Chest (RWC) – not a fragile “nest egg.” By definition, your RWC should afford you enough flexibility to seize attractive “Aggressive Growth Opportunities” (AGOs) as they come along (again, as presented in the portfolios laid out in my monthly guides). China is certainly a candidate for such AGOs, as are India, Brazil, Russia, oil, gas, gold, silver, copper, real estate stocks (REITs), and pretty much anything else that happens to meet my strict criteria at any given time. That’s why I say you must “take time” for the monthly guide portfolios every month!
© Adam Feik
Take Time for This
This article is for informational purposes and does not constitute individualized investment, financial, tax, or legal advice. See additional disclosures here.
