China stocks

Since I do not have Bloomberg any more, I do not keep track of stock market indices on a daily basis. Hence, it was a surprise to find that Shanghai Composite and Shenzhen Composite indices were up 40% YTD slightly outdoing India and Indonesia. Up to end-July or even end-August, Shanghai Composite was flat for the year or slightly down. This is quite suspicious. I wonder if the China government felt that it was a loss of face for them to be eclipsed so comprehensively by India and Indonesia stock markets.

If one looked at MSCI China index, it is up only 3.86% YTD. Annualised 5-year return is -0.41% whereas MSCI-India’s comparable figure is 2.6% and MSCI-Indonesia is 5.5%.

Further, this year’s performance of MSCI-India is 29.1% and MSCI-Indonesia is 24.4% and they are consistent with the performance of benchmark indices. China’s is vastly different.

Performance of China stock indices in the last three to four months appears artificial, suspicious and hence unsustainable, in my view.

We are the grains

This is one of the comments:

“We will vote out immediately anyone anywhere who decides to give us the truth. We want our goodies and our lifestyle and woe-be-tide anyone who wants to take away anything that is our right!”

Another one:

“The national ethos seems to be; “How can I get ahead by the quickest means possible, pay the least amount of tax possible and use the system to my benefit.”

They were from an Australian macroeconomic blog. The post that triggered those comments is here. However, these statements can apply to most nations today – America, India, Britain, China, Singapore, UAE, etc. See, for example, this post about Sweden and asylum seekers.

We continue to pile up grains on the mountain of sand. Sometimes, nature is kind to us. The mountains collapse before they get too big. So, the damage to societies and economies is relatively limited. Examples: 1965-1982, 1987, 2000-2002. Sometimes, they collapse after a big pile builds up, triggered by a tiny grain which we cannot see. Examples: World War I, World War II, 2007-08 crisis, etc.

For example, this could be that small grain of sand or this one. Or, it could be this one. Or, some non-linear combination of some or all of them.

So, the question – as we enter into 2015 – is what awaits us there.

China rate cut and other links

Interest rate cuts must be sanctioned at the State Council level (i.e. above the PBOC Governor’s pay grade) which endows them with great symbolic import. The move to lower interest rates is an unmistakable clear signal to the provinces that the attitude of the top leadership towards the growth-inflation trade-off has shifted decisively. [Link]

That is the key. The rate cut, in and of itself, is not significant. But, what it signals is the key. If the government was quietly trying to restart credit growth, one has to be very worried, actually.

However, China stocks have done quite well in November. MSCI China A 50 index was up more than 12%. I am not in a position to figure out the rationale, though. But, that is not the only thing that I am unable to figure out these days – whether in or about financial markets or outside of it.

Trust loans (loans made by wealth management clients to corporations through special structures) are not defaulting as much, some say. May be, the bailouts are happening and that may not be good news for cleaning up of the sector. Check out the latest story in FT here. It is the story of a failed or failing ‘non-financial guarantee company’ (whatever it means).

There is a post in FT’s ‘Beyond BRICS’ that shadow financing risks have begun to ebb. The post did not sound very persuasive to me. Even if true, the legacy of shadow banking loans is too large to be wished away. This is a different take on the same phenomena.

There was much excitement about estimates put out by two economists on how China had wasted USD6.8trn in investments. That the report was written by two government researchers added to the excitement. One should assume that the message was more in the fact that such a report was written and that such a number was put in the public domain at all, rather than in the accuracy of the estimate. It is impossible to know this number, of course.

This guest post in FT, by economics at Oxford Economics, is rather clear on the fallout of the China credit boom-bust on public finances. I have a lot of sympathy for it.  My Discussion Document for the Takshashila Institution on China Devaluation risks was along similar lines.

I read elsewhere that those who forecast a substantial depreciation of the Yuan in 2015 are being silly because they are not taking the political economy into account. China is trying to forge closer links with countries in Asia (economically at least). A maxi depreciation or devaluation would be counterproductive. There is some truth to it. When big nations adjust their currencies, the move is always as much political as it is economic. But, big nations also sometimes (mis)calculate that they could get away with it.  Second, it is a function of how desperate they become about their macro-economic situation. On that, opinion still continues to differ rather widely.

In the final analysis, on Chinese economy, there is lot of heat, dust and noise (this is an example of noise without content) but we are none-the-wiser for them. At a minimum, caution is warranted on sounding the ‘all clear’ on the Chinese economy.

Grain of sand

“In this simplified setting of the sandpile, the power law also points to something else: the surprising conclusion that even the greatest of events have no special or exceptional causes. After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point. What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size .” [Link]

I think we ought to remember this very well because we look for triggers to cause bubbles to collapse, in financial markets, for example. In fact, our expectation is that bigger the bubble, the bigger and proportionately important trigger for it to collapse. Right now, everyone is focusing on the obvious trigger: that the Federal Reserve would raise interest rates. It may well not do so but yet the bubble can collapse simply because many small things add up.

I came across think from John Mauldin’s ‘Thoughts from the Frontline’ titled,  ‘On the verge of chaos’ published on 23 November 2014. It is well worth a read. The paragraph above comes from a a book that he has cited in his TFTF published in April 2006! In June 2006, financial markets began a six-week period of turmoil and turbulence.

GMO’s third quarter newsletter too is out and Jeremy Grantham has his own outlook on market, on fossil fuels and Ben Inker has written on the outlook for returns on financial assets titled ‘Purgatory or Hell’. All of them are worth a read.

Greenspan’s conversation with Gillian Tett under the auspices of the ‘Council on Foreign Relations’ in October 2014 was very insightful. I will blog on topics ranging from gold to inflation to bubbles that he addressed in that conversation.

If you read these links and reflect on them, you will know why the ‘grain of sand’ theory makes sense.