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Follow-up to Beating a Dead Horse by Vitaliy Katsenelson of Contrarian Edge and Active Value Investing
The Conclusion: Beating a Dead Horse (to Death)
Courtesy of Vitaliy KatsenelsonMy “Beating the Dead Horse” article ended with a very insightful conclusion “Need I say more?” I received a dozen emails that said – you DO need to say more. So here I am saying more:
What do we take out of this? The Chinese ascent over last decade has lowered the degree of separation between China and the global economy. What happens in China doesn’t stay in China (not anymore); it spills over to the rest of the world.
Today, Chinese economic growth is the force pushing the global economy. The quality of this growth, however, is low as it is predicated on massive (forced) lending and thus unsustainable. As Chinese growth slows, China will turn from a wind into sails of global economy to its anchor. The impact will be felt in many, often unsuspected places.
It will tank the commodity markets, commodity producers and commodity exporting nations. Let’s take oil, for instance. As incremental demand from China collapses, oil prices will follow, taking the Russian economy with it, as Russia is for the most part a one-trick-petrochemical-pony. According to GavKal Research China accounts for 15% of Brazil’s exports (up from 1.5% a decade ago), significantly impacting the economy of that South American nation.
Demand for industrial goods will fall off the cliff. China consumed a lot of those goods – $550 billion worth annually (also according to GaveKal Research). So if Caterpillar expects to sell more of its yellow earthmovers to China, it will have put that thought on hold for awhile. (Side note: CAT’s CEO expects CAT’s earnings “$8 to $10 per share within five years if the world economy recovers”. Let me put it into a proper context: in 2007-2008 circa when its margins and sales were at all time high, double their historical average, CAT earned about $5.50 a share. Good luck!)
Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5% mortgages and 6% car loans.
Identifying bubbles is a lot easier than timing them. An astute observer could have seen the Japanese bubble developing in 1986, 1987 and 1988, but he would have been “wrong” until 1989. Now sprinkle on top of this the Chinese government’s willingness to do anything in its power to postpone the bursting of the bubble and the complexity of timing increases exponentially.
Those of you who are familiar with my writing on this subject may rightfully accuse me of beating a dead horse – or in this case a dead dragon. But I firmly believe that those who invest in China or ignore the consequence of very likely Chinese economic malaise do so at great peril.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo., and he teaches a graduate investment class at the University of Colorado at Denver. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007). To receive Vitaliy’s future articles my email, click here.
