Global Macro Monitor produces informed opinion about markets and the global economy. This was originally published on January 17, 2011
During the 1990’s when the emerging markets were still emerging a friend of ours wrote a research report on pre-restructured busted Russian debt titled, No Rush to Buy, No Russians Buying. The point was the Russians knew the prospects for the debt much better given the country’s lack of transparency and the general relative ignorance of foreigners.
Back then the market also traded Nigerian debt and Brady Bonds based on whether or not the country’s generals were actively buying the debt as the military was the ultimate insider as to whether the next coupon would be paid. The same concept – insiders know best — applies for those who closely follow the buying and selling of stocks by company insiders or management.
Given our confessed lack of ignorance on what is really happening in China’s economy, we look at visible indicators to get a sense of what it truly going on, such as the stock market. Market indicators are far from perfect and not always reliable, but it sure the heck beats guessing, “shooting in the dark,” or trusting your capital to the market cheerleaders.
Last night the Shanghai Composite broke key support of the 200-day moving average and the neckline of a technical head and shoulders (H&S) pattern. The chart below shows the price point of the current break is lower than the penetration of the 200-day in late December, which is reflective of the short-term downtrend. The next key support level is 2, 600.
The markets have been flakey of late, however, as there have been several recent H&S topping patterns, including in the Hang Seng and the $/Euro, which have proved unreliable sell signals. Given the seriousness of Asian policymakers to fight inflation and to limit property bubbles, however, we give the Shanghai H&S and 200-day cross a higher probability of following through. P&G must be minting coin with all the traders reaching for the H&S these days!
This leads to our next concern. Given the commodity story is driven and dominated primarily by the China theme, we think there is a pretty good chance this sector could roll over in the near term. Commodities are a very crowded trade and our sense is the levered community is massively long.
Recent price action exhibits all the characteristics of a blow-off top and some of the leaders already seem to be trading at stall speed. Furthermore, as the chart below illustrates, since November the Shanghai and commodities, which have in the past tracked each other relatively well, are in a huge Willey E. Coyote divergence.
Finally, we find the last chart on China’s money supply growth very interesting. Not unlike other countries, when the growth of the broad money supply outpaces nominal GDP growth, asset bubbles and eventually price pressures tend to develop throughout economy. China’s rapid money growth in excess of nominal GDP growth in 2005/6 helped to inflate the Shanghai Composite, which rose from around 1,100 in mid-2005 to an intraday high of over 6,100 in October 2007. At the close on Monday, the Shanghai is down 56 percent from its all-time intraday high.
The monetary expansion which drove the Shanghai is minuscule compared to what took place after the financial crisis, however. The Fed is often demonized, including, sometimes by us, for printing money to help stabilize the financial and economic crisis. But take a look at what happened in China.
In the U.S., the central bank printed and created money through the expansion of its balance sheet. In China, the government pressured the banks to create money through expanding and directing credit to specific sectors.
The chart illustrates as nominal GDP growth was collapsing in 2009, the broad money supply in China was growing close to 30 percent by the end of 2009. This helped the Shanghai Composite recover a bit, but inflated other bubbles, including and mainly in the real estate markets. We hear rumors of, and see pictures of empty Chinese shopping malls and cities pinging around the internet, which is the result of the easy and nonmarket credit included in the latest round of China’s monetary expansion.
Doesn’t this sound a little familiar? First a stock bubble, then a monetary driven real estate and construction bubble to stimulate growth?
We’re not saying China is going to collapse anytime soon and they do have almost $3 trillion in foreign exchange reserves to help cushion any hardship as monetary policy downshifts. But we know that a 30 percent growth in the broad money supply, coupled with just 10 percent nominal GDP growth, must have given birth to many bodies swimming naked, which will be exposed as the credit tide goes out. Whether they’re allowed to officially surface for all is an open question. We just hope the markets will be a clear enough signal as to their size and magnitude.
Like everyone else, we are flying almost blind in this dimly lit world of the markets. We realize our model and view of the world could be wrong and learned to try and have as little of our ego as possible vested in our models and views. The only thing we’re certain of is the markets, as they have in the past and will continue to do so in the future, beat our egos like a drum. We’ll have no problem revising or ditching our view all together if we lack market confirmation. We always try and heed the words of the great Todd Harrison over at Minyanville.com, “discipline always trumps conviction!” Stay tuned!