The following are the latest “dots” from China:
- China accounts for about one quarter of the new demand for oil.
- China demand for gold in 2009 was up 22%.
- China apparently sold US Treasuries and is diversifying its reserves.
- China’s power consumption is up 40% over the last year.
- China has the world’s second largest power capacity and rapidly adding more.
- China’s increase in imports from Australia and Brazil are each up over 40%.
The yield gap between short term US Treasuries and longer term Treasuries has reached a record level. To some in Bondland this is an indicator of “stagflation.” Stagflation is not an erotic party for a soon-to-be groom, but a condition of high inflation and stagnant economic growth. During stagflation, the price equilibrium between materials prices increases, (think oil, already about $80 a barrel), and includes the inability of end goods and service producers to raise prices.
The Interconnection Between China and World Economies
In order to head off massive social unrest in China, its latest dynasty in power is driving a significant increase in consumption. New buildings are going up next to empty or near-empty buildings. The history of the fall of Chinese dynasties is always the same. Social unrest eventually leads to the fall of authority. The present leaders in China are very conscious of their history and are acting accordingly. The difference this time is that China has, in many respects, become the economic growth locomotive for the world. Even the rumor of any disruption within China can affect the prices of US Treasuries. Almost all other publicly-traded securities in institutions’ portfolios are priced off of US Treasuries. In addition, for almost all commodity-exporting nations, China represents their single largest growth market. To paraphrase an old saying about the US, if China catches a cold, most of the rest of the world will get pneumonia. Remember the fear is that a rumor can cause the disruption within China as well as a rumor external to China. We saw the speed and impact of largely untrue rumors on the owners, clients, counter-parties and employees of Bear Stearns and Lehman. Notice the concerns about the “PIIGS” (Portugal, Ireland, Italy, Greece. and Spain) had on the Euro as well in part on Sterling.
Implications for Equity and Fixed-Income Markets
Nothing that I have said here is a new revelation to those involved with the investment community. Have these denizens of the deep already appreciated the chances of such disruptions? Have they added an additional discount into their valuation constructs? I don’t know. My current guess, (which may change with an overseas conference call tomorrow morning), is that the fixed income market, normally the most sophisticated market, has not materially discounted the risks of either a Chinese-oriented disruption rumor and/or a concern as to stagflation if things just mellow out.
Equity Market Recovery
The recovering equity market is like to an addict swearing that he will never again succumb to induced happy feelings. Currently, many stock prices have adjusted to earnings improvements from tighter expense controls and pedestrian revenue growth. Relying on statistical history, which could be a mistake, major parts of the stock markets appear to be fairly priced. Fair in the sense of representing a price that discounts both a return to normal growth and periodic recessions, but not depressions. If we have begun a new “bull” market, as some believe, there is comfort that prices are not fully priced on what good news could occur.
Our Approach at Lipper Advisory Services
Our management of discretionary accounts is to maintain very high quality and quite short-term fixed income holdings, including money market instruments. In terms of equity positions, we are mainly invested, but have some dry powder to add a couple of new positions and a willingness to switch existing holdings into, using Sir John Templeton’s term, “better bargains.”
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