texto haroldo maio 1

8/6/2019 texto haroldo maio 1

http://slidepdf.com/reader/full/texto-haroldo-maio-1 1/4

Financial markets and China

Bubbles and busts

WHEN does a bull market become a bubble? And how can we rationally identify when a bubble, by definition an irrational event, will burst? There have been many attempts to answer thisquestion over the years; the shadows of Charles Kindleberger and Hyman Minsky loom over anyauthor who attempt to tread this path.

In a new book, Boombustology: Spotting Financial Bubbles Before They Burst, VikramMasharamani makes a valiant attempt to add new perspective. Broadly speaking, Kindleberger and Minsky focused on credit growth and on trigger events that allowed investors to believe anew era was in place and thus new valuations might be justified; thus railways in the 1840s andelectrification and radio in the 1920s. Masharamani adds plenty of detail on behavioural finance,the idea that investors' actions are guided by psychological biases, and by structural changes inthe market, such as financial innovations or new regulations. Thus, the final phase of tulipomaniamay have been caused by the introduction of options, which allowed investors to make a levered bet whilst limiting their downside.

Readers may be most interested in one of his last chapters, which applies the criteria used in therest of the book to China. China has seen cheap money, rapid credit growth, a property boom, adodgy financial system, signs of conspicuous consumption (the art market, skyscrapers), a new paradigm (China will dominate the world) and policy distortions (lending decisions made bycentral or local government). China's demand has in turn driven the commodity boom.

There is a nice table in Jeremy Grantham's latest note at GMO which shows the proportion of global commodities consumed in China; 53% of cement, 48% of iron ore, 47% of coal, 45% of steel and so on. Thus if China turns out to be a bubble, commodity prices will presumablycollapse including gold. Mr Grantham's focus is more Malthusian; the combination of a rising population and raw materials that are more scarce, or more expensive to develop, will putupward pressure on prices.

I find myself in sympathy with both these arguments which seems a little paradoxical. Thesmooth nature of reported Chinese growth, the massive government-led investment expansionand the blithe extrapolation of these trends into the future make me very suspicious, but I haveno idea when the trend will break. If it keeps going, then I think commodity-led inflation will bea problem; if it doesn't then the world will have a problem generating growth.

Back in the developed world, Martin Barnes of BCA Research has attempted to identify whether equities are due for another bear market after their spectacular rally since early 2009 (the S&P500 has doubled since its beastly low of 666). the factors he examines are monetary conditions,valuation, the economic outlook, technical indicators and cyclical patterns (such as thePresidential cycle). On the monetary indicators front, he pojnts out that the Fed is unlikely totighten any time soon and the yield curve is steeply upward-sloping, both supportive factors. Heis right, of course, but why isn't the Fed likely to tighten soon? Because of the weakness of the



financial system which made the Fed push rates down to zero, ensuring an upward-sloping yieldcurve. With the system so weak, should the market have doubled?

On valuations, he points out that these are not helpful short-term indicators. He does cite theShiller p/e (it averages earnings over 10 years to smooth out the cycle) which is 23.3 at the

moment. However, he says the long-term average is 20, whereas Mr Shiller's website shows it as16.4, making the market around 40% overvalued and in line with one of the 20th century peaksin 1966. (Mr Barnes tells me that he has used the post-1950 average.)

As to the economy, well we are not very good at forecasting recessions so that's a difficult one. Neither the ISM or the leading indicator is pointing to recession although, regarding the ISM, Mr Barnes points out that

Bear markets often began when the index was strong and rising

The technical indicators aren't telling us much. As for the presidential cycle, we are in the third

year which is the most bullish. But that is because the Fed is supposed to ease policy and, unlesswe get QE3, it is hard to see what else the US central bank can do.

If we apply the Kindleberger/Minsky model to the developed world, we have easy credit and,arguably, a new paradigm; a commitment by the Fed to prop up asset prices. What we don't haveis wild public enthusiasm or a focus on one sector with crazy valuations, like the dotcom stocks.So it's not quite a bubble; more the aftershock period of past bubbles. I'm inclined to agree withGervais Williams, the smallcap fund manager from MAM whom I met this morning, and who believes that the overall market may be going nowhere for the next 10 years although there maystill be scope for investors to make money if (a big if) they can pick companies that will growtheir dividends.

At the front line in the battle between Chinese suppliers and their

customers

BUYERS who come back for every iteration of the historic Canton Fair, a twice-yearly trade fair in Guangzhou, will tell you that only one thing really changes: the reasons given by suppliers for why dirt-cheap prices have to go up. In 2008 price increases were blamed on factory relocationsrequired for the Olympics; in 2009 it was floods and power shortages; and in 2010 it was labour and regulation. At this year¶s spring fair, which runs from April 15th to May 5th, the battle over pricing is being fought more keenly than ever.

To an outsider, the prices alone suggest there is nowhere to go but up. A nicely packagedtoothbrush sells for just $0.10, sunglasses for $1-3, watches for under $2 and office chairs start atunder $30 (with the proviso that in each case the order must be for hundreds of items or more).

The list of pressures on suppliers, meanwhile, runs on and on. Labour is not only expensive, it isscarce at almost any cost. Even the most lethargic salesperson can provide a take on the impactof commodity prices²be it petroleum, steel, cotton or wood²on products.



Smaller sellers also mention the pinch of pricier credit. Last October the one-year corporatelending rate that serves as a widely cited benchmark was 5.31%. In April, after a series of increases, it reached 6.31%. That increase is substantial enough²almost 20%²but the trueextent of the tightening seems to be much greater than official rates suggest.

That is because a lot of lending in China takes place in shadowy private markets. According toMacquarie Securities, the so-called ³Wenzhou rate´, based on the private-borrowing market in afamously entrepreneurial city in south-east China, has risen to 6-8% a month, up from about1.5% a month in late 2008 and matching levels seen in early 2008 when credit was genuinelyscarce. Pawnbrokers, Macquarie adds, are charging 4% a month for loans that are, by their verynature, fully secured.

Access to lower rates seems, at least in part, tied to how much employment a company provides.The bigger manufacturers²those with perhaps more than 10,000 workers²seem sanguine aboutgetting hold of credit (if not workers and materials). Smaller suppliers are in a tougher position,which gives added clout to the trade buyer who can pay more upfront or the full balance fast or,

preferably, both.

As is often the case in China, new terms are being added to contracts sealed at the fair. The mostsignificant stipulations are tied to movements in the yuan, says Paul McLaughlin, a longtimetrade-fair customer from a British sourcing company, Libra. In the past prices offered bysuppliers were good for three months. At this year¶s fair there is a broadly accepted provisionthat voids any price offer if the yuan appreciates to 15.4 cents or more (it is currently worth 15.3cents). Mr McLaughlin¶s suppliers are also uncharacteristically willing to levy huge increases² in one case, of 40%²and walk away if the terms are not met.

They are willing to do so despite the fact that returning customers like Mr McLaughlin are

thinner on the ground this year. One large manufacturer says the number of visitors is down bymore than 15% (whatever official figures might say) because Arab, Japanese and European buyers are preoccupied by domestic problems.

The notion that disruptions like the Japanese earthquake and unrest in the Middle East could push prices down is not much discussed at the fair, but the possibility of an abrupt price declineis hardly inconceivable. China¶s inflationary problems first surfaced in food prices, and food prices may also herald the disinflation to come. In 2009 vegetable prices shot up; they werestrong last year as well. Good arguments were given for these price gains²among them, thatincreased wealth and better nutrition lead to ever more consumption²and investment and production ballooned. But the prices of many vegetables have since crashed, with China Daily giving front-page treatment to a farmer in Shandong province who, faced with vast losses,committed suicide. Suppliers may have the upper hand for now but old trade-fair hands will tellyou that arguments about price are never over.



Documents

texto haroldo maio 1