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Poststeroids Economics
Here is my latest article in the October issue of Institutional Investor (see below). But first I want to bring to your attention two articles from the NY Times. The first one takes a deep look at Ordos, the infamous Chinese ghost town built for 1.5 million residents (here is a slideshow from Time magazine).?A few excerpts:
Kangbashi was projected to have 300,000 residents by
now. And the government claims that 28,000 people live in the new area.
But during a recent visit, a reporter driving around for hours with two
real estate brokers saw only a handful of residents in the housing
developments.Analysts estimate there could be as many as a dozen other Chinese
cities just like Ordos, with sprawling ghost town annexes. In the
southern city of Kunming, for example, a nearly 40-square-mile area
called Chenggong has raised alarms because of similarly deserted roads,
high-rises and government offices. And in Tianjin, in the northeast, the
city spent lavishly on a huge district festooned with golf courses, hot
springs and thousands of villas that are still empty five years after
completion.
If excesses in the Chinese economy were limited to Ordos, it would
just be a little multi-billion-dollar pimple on the pinkie of a
$5-trillion economy. But unfortunately Ordos is symptomatic of much
greater excesses all over China.
“I bought two places in Kangbashi, one for my own use
and one as an investment,” said Mr. Zhang, who paid about $125,000 for
his 2,000-square-foot investment apartment. “I bought it because housing
prices will definitely go up in such a new town. There is no reason to
doubt it. The government has already moved in.” Asked whether he
worried about the lack of other residents, Mr. Zhang shrugged off the
question. “I know people say it’s an empty city, but I don’t find any
inconveniences living by myself,” said Mr. Zhang, who borrowed to
finance his purchases. “It’s a new town, let’s give it some time.”
The second article in the Times tells the very depresseing story of what is taking place in Japan. A few excerpts:
In 1991, economists were predicting that Japan would
overtake the United States as the world’s largest economy by 2010. In
fact, Japan’s economy remains the same size it was then: a gross
domestic product of $5.7 trillion at current exchange rates. During the
same period, the United States economy doubled in size to $14.7
trillion, and this year China overtook Japan to become the world’s No. 2
economy.
This has a such a familiar ring to it; in fact it sounds exactly like
the prediction we often hear that the GDP of the Chinese economy will
overtake that of the US by 20xx. Though it may happen, I would not make
this prediction solely on the basis of drawing straight lines to extend
the growth of the last two decades into the future. This type of
analysis is too simplistic, and dangerous. It is important to
understand the roots of past success, and often past success is the
precursor of a less-than-bright future — Japan is a great example of
that!
The decline has been painful for the Japanese, with
companies and individuals like Masato having lost the equivalent of
trillions of dollars in the stock market, which is now just a quarter of
its value in 1989, and in real estate, where the average price of a
home is the same as it was in 1983. And the future looks even bleaker,
as Japan faces the world’s largest government debt — around 200 percent
of gross domestic product — a shrinking population and rising rates of
poverty and suicide.… the small-business owner, who sold his four-bedroom condo to a
relative for about $185,000, 15 years after buying it for a bit more
than $500,000. He said he was still deliberating about whether to
expunge the $110,000 he still owed his bank by declaring personal
bankruptcy.
I am a value investor and rarely have a view on currencies; I don’t
know how to value them. But the yen hitting a fifteen-year high against
the dollar makes no sense whatsoever. The US has plenty of problems
but it is not Japan, at least not yet. In fact the strong yen in
itself will likely lead to a substantial decline in the yen, as it is
crippling Japan’s export-driven economy.
Poststeroid Economics
By Vitaliy N. Katsenelson
During
the ’80s and ’90s, ignorance was bliss. The global economy was growing
nicely, and analyzing it (or even paying attention to market cycles)
seemed like a waste of time, as the economy came in only three flavors:
good, great and awesome. Even if you misread the flavor, the downside
was that you’d just make a little less money. Value investors prided
themselves on being bottom-up-only analysts, focused on scrutinizing
individual stocks, while top-down analysis — making investment decisions
by looking only at the macro picture — became unfashionable, viewed as
market timing. (I know the above statement may sound a bit over the
top, but over the years I have read and listened to dozens of interviews
with famous and successful investors who declared that they do
bottom-up-only analysis and don’t pay attention to the economy.)
Prolonged and virtually uninterrupted growth brought complacency,
excesses, and debt. Bottom-up-only analysis worked until it stopped
working, as investors discovered during the recent crisis that the
global economy can come in additional flavors: bad, horrible, and
downright nasty. Today the cost of misreading the economy is much
higher.
Two years ago the Great Recession waltzed in — to the great surprise
of homeowners, the Fed, and the banks — and everyone discovered that
house prices don’t always go up. The financial sector, the lifeblood of
our economy, started to drown in the sea of bad debt. As the troubles in
that sector began to spill into the real economy, the government felt
it had no choice but to step in, and the bailouts and stimuli began.
Today it is hard to take a walk through our economy and not meet a
friendly Uncle Sam; he is everywhere. He’s buying long-term bonds and
thereby keeping long-term interest rates artificially low. Since he took
over the defunct (for all practical purposes) Fannie Mae and Freddie
Mac, he is the U.S. mortgage market, because those organizations account
for the bulk of mortgages originated. Of course, he is also on the hook
for their losses.
Our dear Uncle Sam rolls in style; he doesn’t know how to bail out or
stimulate on the cheap. U.S. government debt (at least, the debt that
is on the balance sheet) leapt from about 60 percent of GDP before the
Great Recession to more than 100 percent in 2010. The party of
overleveraged consumers has been crashed by an overleveraged government.
To understand the consequences of the Great Recession, consider this
analogy: The U.S. economy is like a marathon runner who runs too hard
and pulls a hamstring, but finds himself with another race to run. So
he’s injected with some industrial-strength steroids, and away he goes.
As the steroids kick in, his pace accelerates as if the injury never
happened. He’s up and running, so he must be okay — this is the
impression we get, judging from his speed and his progress. What we
don’t see is what is behind this athlete’s terrific performance: the
steroids, or, in the case of our economy, the stimulus.
Obviously, we can keep our fingers crossed and hope the runner has
recovered from his injury, but there are problems with this thinking.
Let’s address them one by one:
• Serious steroid intake exaggerates true performance. Economic
stimulus creates an appearance of stability and growth, but a lot of it
is teetering on a very weak foundation of government intervention.
• Steroids are addictive; once we get used to their effects, it is
hard to give them up. When the first home-buyer tax credit expired, it
was extended for anyone with the patriotic ambition to buy a house. It
is hard to give up stimulus, because the immediate consequences are
painful, but long-term gain has to be purchased by short-term
discomfort.
• The longer we use steroids, the less effective they are. Take
Japan, which was on the stimulus bandwagon for more than a decade. With
the exception of tripled government debt, Japan has nothing to show for
its efforts; the economy is mired in the same rut it was in when the
stimulus started.
• Steroids damage the body and come with significant side effects. In
the case of the economy, the side effects are higher future taxes and
increased government debt, which brings on higher interest rates and
thus below-average economic growth. The hopes that we’ll transition from
government steroid injections back to an economy running on its own are
overly optimistic.
So what does this mean for investors? When we purchase a stock, we
are buying a stream of future cash flows. By doing only bottom-up
analysis, investors implicitly assume that external factors (the winds
and hurricanes of the global economy) have no impact on these cash
flows. That is a brave and careless assumption, especially in a
poststeroid world. Instead, investors should take a more holistic
approach, mixing bottom-up insights with top-down analysis.
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing” (Wiley, 2007) and the upcoming The Little Book of Sideways Markets (Wiley, December 2010). To receive my future articles by email, click here
Twitter thougts (you can follow me on Twitter http://twitter.com/vitaliyk ):
- Very interesting interview w/ ex-Apple CEO in BusinessWeek. Interesting, insightful contrast of Apple vs. Microsoft http://bit.ly/d7Pmcb
- My audio interview with Jim Puplava on Japan/China http://bit.ly/c8rJaO (starts at 40-min. mark)
- Shadow over Asia – my interview with Casey Research about China/Japan http://bit.ly/dA1YPI
- My article on why Barron’s is wrong about Medtronic http://fb.me/JcVbNP2Y
- A fairly good summary of my speech at the Agora conference http://bit.ly/cjZtbk
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V is a complete moron. He's been floating around for years on seeking alpha. It really doesn't get more coventional than V. He loves to talk about Home Depot and Microsoft and how they are under/over valued. Right off the the keynesian/monetarist tit
WTF was that flabby waste of time? VK has often been perspicacious in the past--I hope this is not an example of what he has to offer now...
Sounds like a scene from one of those sci fi movies where an entire population gets wiped out. But, you don’t have to go to China to find ridiculous situations like this. I know of one upscale golf community development in North Carolina where a single 5500 sf home is surrounded by a sea of about 200 empty building lots. The golf couse hasn't been finished either. I hope the owner likes his privacy. He may not have a neighbor during his lifetime. Maybe he can hook up with Mr. Zhang on Facebook.
What part of this is particularly insightful? Does the author ever visit zerohedge? Good points, reasonable analysis, no particular reason to add the chinese connection unless you're going to tie it in to your discussion.
We know this already.
China has their own massive problems building, though we'd like to trade them for ours anytime.
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