On a recent trip to China, I noticed how everywhere cranes constructed new apartments for those moving from rural areas to the big cities. This was true in all of the cities I toured – Xi’an, Ljiang, Shangri-La and Shanghai. New apartment complexes, shopping malls and hotels with luxury brands being erected on former farmland. Chinese families are touring the country with more disposable income. In the Western press, it is reported that new real estate purchases from Chinese natives are fueling the housing market in parts of Canada and the U.S.
The country is an amazing blend of 53 ethnic minorities, each rich in culture, tradition, history and cuisine. The roots are deep and the soil is fertile. 20% of the world population resides there and it is bustling. Financial journals estimate that China will show over 7% GDP growth in 2015; slower than in the past, but on a much larger base of activity.
However, beneath the surface, there are some problems. Firstly, many of those new apartments and hotels are built, but are tenantless. The hyperactive city life, with its high rises and salaries also comes with staggering pollution, stress and poor diets. Although we had three days of blue skies in Beijing, 250 days a year they are grey with smog, and many residents wear masks.
The largest cities in Yunnan province, while expanding, have only about 90,000 residents. Young people from around the country are now looking for work in the area, as the mountain air, clean water and fresh food are more alluring than city pay packages.
Marshall McLuhan once wrote, “The medium is the message.” In China’s case, the government both controls the media and supplies the message. I was reading China Daily, one of several English language papers reporting local and global news, and noticed the words to describe the state of affairs: progress, bullish, strengthening. Crime is low, corruption and pollution declining, and the markets are rising.
Most other governments, and corporations for that matter, would rather be cautiously optimistic or even realistic, and build in a margin of safety to create confidence in the numbers. The reason is that markets move based on reports relative to expectations. Upside surprises in earnings reports, economic variables and inventory reports move stocks, interest rates, commodity prices and markets.
A major issue indigenous to China is that economic growth, savings, investment and prosperity in general are highly influenced by the central bureaucrats. The government controls the leasing of land (duration and cost), taxes, interest rates, tariffs and the flow of funds in and out of the country. In other words, they can make the skies look pink by supplying the rose-tinted glasses. Optimism helps keep people motivated, happy and led. In China’s case, this is particularly critical, as it affects 20% of the world’s population.
Optimism is prevalent on Wall Street as well. Research analysts and economists publish company earnings estimates, asset allocation tables, stock and bond market forecasts to their clients, subscribers and investors. In the vast majority of brokerage firms, the lion’s share of stocks are rating BUY or ACCUMULATE, and stock market forecasts call for indices to rise each year. [link to prior blog]
Although analysts calling stock market crashes are like lottery players—every now and then there is someone who gets the winning ticket—most firms make more money being bullish, as it drives more stock purchases, driving more commissions and fees. Independent research firms, who are paid to give advice, tend to have more sanguine (now called contrarian) views on how to invest.
In China’s case, Bloomberg News reported the following recently:
“The Shanghai Composite has surged 124 percent over the past year through Thursday as margin debt climbed to a record and investors speculated monetary stimulus will revive the weakest economic expansion in more than two decades. The bull market, which turned 935 days old Friday, is the longest since Chinese bourses opened for trading in 1990 and more than five times the average lifespan of previous rallies.”
However, that surge has created an environment of heightened volatility and fear-inspiring declines:
“Futures on the CSI 500 Index of smaller companies dropped by the maximum limit of 10 percent, while contracts on the CSI 300 Index fell 9.5 percent…The stocks favored most by margin traders at the height of China’s boom in mid-June have since tumbled at least 24 percent, helping send volatility in the Shanghai Composite to the highest levels since 2009. The benchmark index has had nine straight sessions of intraday swings exceeding 2 percent.”
Market participants usually take on margin debt when they are extremely bullish. However, recently global investors have dampened their expectations for growth in many developing markets, including China at the same time citizens are still being told that the construction projects will be completed and tenants will fill them.
Disappointment will breed dissent and thus a large-scale problem, especially if there is rampant unemployment, just as living costs are increasing. Stock market uncertainty can have a similar effect, although perhaps on a smaller but no less influential contingency.
In either case, blowing smoke on embers leads to hot flames, and a need for evermore firewood. Those who desire capital stability and investment harmony, like the Chinese government, are best advised to under-promise and over-deliver.