April 2012

China?s View of China

I ran into Minxin Pei, a scholar at the Carnegie Endowment for International Peace. Who imparted to me some iconoclastic out of consensus views on China?s position in the world today.

He thinks that power is not shifting from West to East; Asia is just lifting itself off the mat, with per capita GDP only at $5,800, compared to $48,000 in the US. We are simply moving from a unipolar to a multipolar world. China is not going to dominate the world, or even Asia, where there is a long history of regional rivalries and wars.

China can?t even control China, where recessions lead to revolutions, and 30% of the country, Tibet and the Uighurs, want to secede. All of Asia?s progress to date has been built on selling to the US market. Take us out, and they?re nowhere. With enormous resource, environmental, and demographic challenges constraining growth, Asia is not replacing the US anytime soon.

There is no miracle form of Asian capitalism; impoverished, younger populations are simply forced to save more because there is no social safety net. Try filing a Chinese individual tax return, where a maximum rate of 40% kicks in at an income of $35,000 a year, with no deductions, and there is no social security or Medicare in return. Ever heard of a Chinese unemployment office or jobs program?

Nor are benevolent dictatorships the answer, with the despots in Burma, Cambodia, North Korea, and Laos thoroughly trashing their countries. The press often touts the 600,000 engineers that China graduates, joined by 350,000 in India. In fact, 90% of these are only educated to a trade school standard. Asia has just one world class school, the University of Tokyo.

As much as we Americans despise ourselves and wallow in our failures, Asians see us as a bright, shining example for the world. After all, it was our open trade policies and innovation that lifted them out of poverty and destitution. Walk the streets of China, as I have done for nearly four decades, and you feel this vibrating from everything around you. I?ll consider what Minxin Pei said next time I contemplate going back into the (FXI) and (EEM).

April 24, 2012 - Quote of the Day

Quote of the Day

?They got us into this mess, they?ve gotten great credit for getting out of this mess, and now they are creating even a bigger mess,? said the former chairman of Morgan Stanley International and a colleague of mine, Steve Roach.

Closing My Apple Position

Diary

My Apple April $450-$480 call spread expired deep in the money at the close on Friday. Legally, these expire at midnight on Saturday night, so your broker won?t take these off your statement until the following Monday. The position should be zeroed out and you should receive a cash credit. You will also find that the margin requirement has disappeared.

Your net profit on this position should be $1,855, or? $1.86% for the notional $100,000 portfolio. Well done. Here is how the profit is calculated in detail:

Execution

March $450 call cost?????... $97.60
March $480 call premium earned?-$70.25

Net Cost???????.........?. $27.35

Profit Calculation at Expiration

Expiration value???????..$30.00
Purchase cost ?..??????. . $27.35

Net Profit????????.??.$2.65

Total profit = ($2.65 X 100 X 7) = $1,855 = $1.86% for the notional $100,000 portfolio.

I will go back into another position like this in the future, but only after a substantial dip in the share price. I still think that Apple will continue on its march to $1,000 a share. Coming down the road we have Apple TV and the iPhone 5. Of far greater importance will be the adoption of Apple standards by corporate America, which has long avoided Steve Jobs? creations. This is going on everywhere, and is being hastened by the demise of Blackberry (RIMM). But it is a trip that will take years, not weeks or months.

Thanks, Steve

This is What a Lost Decade Gets You

Diary

With all of the handwringing about the zero return on US equities for the last decade, I thought I'd better take a look at the long term charts. It's very clear that we have been trading in a gigantic sideways narrowing wedge for the last 18 years, defined by 14,000 on the upside and 6,000 on the downside.

The clever investors out there, like hedge funds, have been selling every big rally and buying every dip, laughing all the way to the bank and leaving your average Joe pension fund beneficiary, 401k owner, and mutual fund investor holding the malodorous bag.

What's more, I believe that this state of affairs is going to continue for another few years. You get what you deserve. This view is consistent with an economy that isn't inventing anything new, spends more than it borrows, and lets foreigners take the technological lead through sheer indolence and complacency. We aren't going to Twitter our way to prosperity.

It also fits with 80 million baby boomers withdrawing wealth from the system, downsizing their homes, and plopping everything into the Treasury market. This means that we are much closer to the end of this run in equities than the beginning.

If you have any doubts, take a look at the chart below showing that stocks are more expensive now than at any time in the last nine decades. Should one of the world?s? more structurally impaired economies be commanding one of the highest PE multiples? I think not. This is why I have been using my electric cattle prod and my kangaroo skin bullwhip to herd investors to the sidelines.

The Sidelines Are a Good Place to Be

China?s Coming Demographic Nightmare

Newsletter

Thanks to China's ?one child only? policy adopted 30 years ago, and a cultural preference for children who grow up to become family safety nets, there are now 32 million more boys under the age of 20 than girls. Large scale interference with the natural male:female ratio has been tracked with some fascination by demographers for years, and is constantly generating unintended consequences.

Until early in this century, starving rural mothers abandoned unwanted female newborns in the hills to be taken away by ?spirits.? Today, pregnant women resort to the modern day equivalent by getting ultrasounds and undergoing abortions when they learn they are carrying girls.

Millions of children are ?little emperors,? spoiled male-only children who have been raised to expect the world to revolve around them. The resulting shortage of women has led to an epidemic of ?bride kidnapping? in surrounding countries. Stealing of female children is widespread in Vietnam, Cambodia, Laos, and Mongolia.

The end result has been a barbell shaped demographic curve unlike that seen in any other country. The Beijing government says the program has succeeded in bringing the fertility rate from 3.0 down to 1.8, well below the 2.1 replacement rate. As a result, the Middle Kingdom's population today is only 1.2 billion instead of the 1.6 billion it would have been.

Political scientists have long speculated that an excess of young men would lead to more bellicose foreign policies by the Middle Kingdom. But so far the choice has been for commerce, to the detriment of America's trade balance.

In practice, the one child policy has only been applied to those who live in cities or have government jobs. That is about two thirds of the population. On my last trip to China I spent a weekend walking around Shenzhen city parks. The locals doted over their single children, while visitors from the countryside played games with their three, four, or five children. The contrast couldn?t have been more bizarre.

Economists now wonder if the practice will also understate China's long term growth rate. Parents with boys tend to be bigger savers, so they can help sons with the initial big ticket items in life, like an education, homes, and even cars. The end game for this policy has to be the Japan disease; a huge population of senior citizens with insufficient numbers of young workers to support them. The markets won't ignore this.

April 23, 2012 - Quote of the Day

Quote of the Day

?The US has repositioned itself better than any of its global competitors. Americans are doing what they do best. They?re adapting, they?re moving, they?re finding good, and they?re surviving. That?s where we need to be,? said Tom Barrack, CEO of Colony Capital, and a former principal of the Bass Group.

The Race Towards the Year End Fiscal Cliff

Diary

After spending all of this year ignoring the fiscal disaster that the US is facing at the end of 2012, markets are finally taking off the blinders. That might explain why the S&P 500 has dropped 4.3% so far from its April 1 peak and why it may have more to come.

Remember the debt ceiling crisis of the summer of 2011? You know, the one that triggered a 25% collapse in US stock prices? The compromise that was struck required major progress in deficit reduction by November, or drastic measures would automatically kick in.

Well guess what? Zero progress has been made. None can be expected until after the November 6 election as long as both parties expect to win. That allows just eight weeks for the president and congress to repair some of the most serious fiscal damage ever to strike the country, three of which will be vacation weeks.

Add up the numbers and the potential impact on the economy is particularly grim. If congress takes no action by year end, a series of tax increases and spending cuts will automatically take effect that will squeeze the life out of the economy. Think Austerity with a capital ?A?. Think Spain with a capital ?S?. Even Federal Reserve Chairman, Ben Bernanke, a man normally disposed to making cautious, taciturn statements has described the problem as ?A massive fiscal cliff?.

Here is the forbidding breakdown in terms of their effect on annual GDP growth:

-0.2%? Expiration of unemployment benefits
-0.8%? Automatic spending cuts required by sequestration
-0.8%? Expiration of payroll tax cuts
-1.0%? Expiration of Bush tax cuts

-2.8%? Total

The big problem is that the economy doesn?t have much economic growth to give away. My own forecast for GDP for 2012 is still at 2%. But that is based on the assumption that corporate earnings would bring in 5% growth, down from last year?s torrid 15% growth. My calculator tells me that 2% -2.8% = recession. Danger! Danger! Current stock prices are not reflecting this reality.

It gets worse. The 15% of companies that have reported Q1, 2012 earnings so far have delivered a much more modest 1% growth, well below my own minimal expectations. That is with the earnings cycle front loaded with the most profitable companies in technology. It also reflects a lot of business pulled forward into Q1 from Q2 and Q3 by the warm winter. Yikes!

It?s hard to see how this ends happily for the stock market. The best case scenario would be for a lame duck president and congress, no longer worried about reelection, to cobble together a deal in December. Some sort of resuscitation of the ?grand bargain? that was on the table last summer, but suffocated in its crib by the Tea Party because it included tax increases, might work. Alternatively, if one party or the other sweeps the election, it could ram through something. But that outcome is unlikely. A divided country gets the dysfunctional government it deserves.

The headache for equity investors and risk investors in general is that even the mere discussion of the weighty matters triggers a huge ?RISK OFF? trade. Confidence withers, business and consumer spending slows, and the economic data takes a hit. That?s what happened last summer, when the markets discounted a full blown double dip recession that never actually happened. It?s a given that our representatives in congress don?t understand this.

Is This Our Fiscal Policy?

Another Alarm Bell

Newsletter

I am a numbers guy. Show me the data and I?ll draw my own conclusions, ignoring conflicted brokerage research, the paid talking heads on TV, and all the politically motivated garbage pumped out by industry sponsored fake research institutes. I am also a glass half full kind of guy, willing to make a positive interpretation when all else is equal. After all, over the very long term, everything goes up in value.

Having said all of that, I have to tell you that the economic data flow has recently been rolling over like the Bismarck. In January and February it was uniformly positive. In March, it turned decidedly mixed. Since the beginning of April they have turned overwhelmingly negative. This is what tops in both the economy and the stock market are made of.

I normally don?t bother you with such details, as most readers prefer me to distill my comments down to ?BUY? or ?SELL?. But the deterioration has been so dramatic in recent weeks that I thought you should see what I am looking at. Let me give you this week?s sampling:

April 19? March existing homes sales -2.6%
April 19? Philly Fed down from 12.5 in March to 8.5 in April
April 19? Leading economic indicators down from +0.7% in February to +0.3% in March.
April 19? Weekly jobless claims down 2,000, but held most of last week?s 13,000????? .?????????????? spike upward
April 17? New permits for Single Family homes -3.5% in March
April 17? Housing starts down from 2.8% in February to -5.3% in March
April 16? February business inventories +0.6% because people aren?t buying stuff.
April 16? Empire state down from 22 in March to 6.6 in April
April 16? March Consumer Price Index 0.3%, but most of the increase was for?????? gasoline.

Any one of these data points is relatively unimportant. When they are all moving in the same direction, that is important. And this has been going on for more than a month now. When preparing my last two biweekly strategy webinars I had difficulty finding any positive data points to report. The only plus figure that I have seen recently was the International Monetary Fund?s upgrade of its outlook for the global economy for 2012 from 3.3% to 3.5% which no one pays attention to anyway.

There is a big problem for the stock bulls in all of this. We have a stock market that is priced for perfection, having taken earnings multiples up from 11 to 14 in six months. As a result, we now have a market that is priced for 4% GDP growth in a 2% GDP economy. But guess what? The 2% GDP is coming through. Instead of perfection we are getting mediocrity. Look out below.

I am not a permabear, but I know plenty of people who are. Maybe it is time for me to start paying them more attention, reading their research, answering their e-mails.

Maybe I Should Start Returning His Calls

Who the Electric Car Helps and Hurts

Diary

With gasoline prices staying stubbornly high, the number of hybrid and electric cars manufactured is soaring skyward. Toyota Motors (TM) is far and away the biggest beneficiary as the world?s largest manufacturer of hybrid cars with its Prius family that now extends to five models. Nissan Motors (NSANY) is expected to complete construction of a Tennessee plant that will produce 150,000 all-electric Leafs a year in 2014.

Beyond these obvious beneficiaries it gets a little more complicated. I found this interesting table from the QVM Group that listed the impact that electric cars, which will soon be produced at one million units a year, will have on the supply and demand for raw materials. Here are my comments:

Aluminum (AA): Lighter cars need more aluminum for bodies
Coal (KOL): Greater electricity needs increase demand from this cheapest of sources.
Copper (CU): Big increase in demand for copper wire from electric motors and the grid.
Corn (CORN): Kiss the pork barrel ethanol program goodbye. Demand falls.
Natural Gas (UNG): Some 100% of new power generation facilities are gas fueled.
Lead: Older technology batteries still use lots of lead.
Lithium (SQM): You can?t lose. If electric car demand doesn?t kick in, then fertilizer demand will.
Nickel: The same batteries use nickel
Oil (USO): Some analysts think gasoline demand could drop by 50% by 2020 because of electric cars, mileage improvements in conventional cars, and the discovery of huge new fields in the US with fracking technology.
Platinum (PPLT): Demand falls from fewer catalytic converters, but this will be offset by growing monetary demand for the white metal.
Uranium (NLR) : More power demand means more nukes everywhere.
Zinc: Battery demand again

Who Am I Helping?

April 20, 2012 - Quote of the Day

Quote of the Day

?The biggest tumor that we are now facing for the economy is the shadow inventory of housing. We now have six million units that are delinquent, in default, or foreclosed, and 15 million other units for sale. Demographic demand can only soak up one million units a year. It is the biggest dilemma for homeowners,? said Tom Barrack, CEO of Colony Capital, and a former principal of the Bass Group.