Introduction
A number of years ago
a good friend attended a Chinese Embassy party where a very senior member of
the government commented that while the West owned the watches, the Chinese
owned the time. This critical distinction has stayed with me in terms of
looking at investment horizons.
One Belt One
Road
While there has been
some US coverage of the “One Belt One Road” meeting in Beijing this Sunday hosted by Xi Jinping with Vladimir
Putin in attendance, most of the US attention has been focused on the dismissal
of one employee at the discretion of the President. As a long-term investor, I
believe this is a misplaced focus. On the Chinese side the implications of the
massive One Belt One Road Initiative may have implications into the next
century. The US focus appears to be on the electoral contests in 2017-2020.
I find it is
interesting that China is using a staging investment philosophy somewhat similar
to our TIMESPAN L Portfolios®. China announced some of
the outlines to this the One Belt One Road Initiative in 2013. From an economic
vantage point it was a brilliant way to export its excess steel and cement
capacity in building long line railroads and some internal subway systems. It
also would reduce shipping costs of Chinese manufactured products that
potentially could be exported to 60 countries, part of the land and sea
bridges. This
is somewhat like President Eisenhower's US interstate highway building program
that required new federal highways to be built with the ability to handle the
transportation of heavy tanks. As the rail and port facilities are built, China (even without moving its
military) will have strengthened its ability to influence all of the surrounding
countries. Some have called this drive
as "Globalization 2.0.” Compared to the Russian leader in attendance, the
US is sending a senior director for Asia at the National Security Council. While there is definitely a
military threat in this initiative, by far the bigger threats are economic and
political.
The One Belt One Road
Initiative is not without substantial
risks.
The planned funding requires a series of public/private partnerships. Every
analyst and most investors should have knowledge and respect for past
histories. Around the world in the last half of the 19th Century, there
was a surge of railroad building. The British were particularly active in South
America. I suspect that almost every railroad company started during this
period eventually went bankrupt. In one case the largest and most
powerful UK merchant bank almost went under because of its Latin American
exposure. I can not think of a long line US railroad that did not enter or
threatened to enter bankruptcy. Some of the same problems exist today. One of
the Chinese-backed African rail lines is not expected to reach breakeven for
the first eleven years, and we all know how reliable the predictions of
breakeven have been.
If we of short memory
fail to remember the global distribution of less-than- healthy US residential
mortgages, we could have a replay with global distribution of private
partnerships through the growing power of Chinese financial services companies.
Thus, for the global investor there is both downside and upside as this
initiative grows. I maintain that no matter what you invest in; stocks, bonds,
commodities, real estate, currencies, or intellectual property, your returns
could pivot on what is happening or rumored to be happening in China.
What are the
US Markets Focused On?
Investors into the US
market are focused on the very short-term to intermediate future while China is
exercising its long-term options.
The following are
briefs tidbits that have crossed my computer screens this week:
1. Dow Jones Industrial Average - A minuscule
decline closed on of the two price gaps in its current chart. The
other two major stock indices, S&P 500 and NASDAQ, still have price caps. (One
wise market analyst suggests that we need a 5% decline before we can resume a
meaningful upturn.)
2.
JP Morgan has noted that 37% of NYSE volume is executed
in the last half hour of the trading day as Index funds rebalance.
3. There is some justification in the adage “Sell
in May and Go Away.” Since 1950, the period November through April
does better than the other six months, 71.64% of the time.
4. According to its inventor, the CAPE ratio,
used as a valuation measure, explained about 1/3 of the variation in the ten
year returns. (Surprisingly this is roughly the same chances of a favorite
winning in most horse races.)
5. Ray Dalio, who manages one of the largest
hedge funds, sees no major economic risk in the next year or two. (This
could be an important cautionary flag.)
6. The highly respected GMO seven year
prediction for real return on stocks is -3.8%
7. Vanguard believes we are in a period of slow
growth; e.g., a 60/40 asset allocation will produce a return between +3% and
+4.5%. (If they are correct, which I doubt, the average foundation will be
liquidating its base each year if it has a mandated 5% pay out.)
8. Turning to the increasingly popular European
investing, there are two points worth considering: (a) the
current price of the Stoxx 600 Index is where past rallies have peaked out, and (b) over half of the ETF flows into non-domestic funds came into three Index funds and these were somewhat
smaller than the ETF redemptions in two domestic Index funds. (These suggest to me that main players in
the ETF market are trading-oriented, and may not be
patient during surprises.)
Investment
Conclusions
Despite the reputation
of highly speculative retail Chinese investors, the Chinese government is
playing a long game.
The US market is
increasingly short-term focused. This may, over time, give us longer term
investors a bigger barrel to fish in.
As we structure various
markets I am wondering whether our assorted valuation measures need to be
adjusted due to fundamental changes in supply and demand.
Any thoughts?
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A. Michael Lipper, CFA
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