Saturday, March 17, 2012

Our economic future: the good, the bad, and the ugly.

The Good. The Dow rose for the seventh session Thursday. closing at 13,253. and the S&P climbed above 1,400 (to 1,403) for the first time since June 2008. Thursday was the first time in history that together the Dow has been above 13,000, S&P above 1,400, and Nasdaq above 3,000 (it closed at 3,056). Our FOX Index, which watches such movements (it marks the distance above or below a “healthy market” of 12,000 Dow, 1,300 S&P 500, and a NASDAQ of 2,500) was at its all-time high Thursday of +1,912 (see chart; the Index dropped 20 points Friday).

Jobless claims fell by 14,000 Thursday, providing further evidence that the US economy is on the rebound.

The Bad. Amity Shlaes, writing at Bloomberg, believes the next economic “black swan” (she doesn’t use the term) we face is inflation. She mounts a century-long case to show inflation comes suddenly, repeatedly, and with devastating force. Yes, but such a “black swan” event cannot be predicted; inflation may remain contained.

David Rosenberg, in the Financial Times (U.K.), provides a less dramatic picture of trouble ahead. He first notes signs that stocks could continue to rise:

• corporate earnings have more than doubled off the 2009 depressed lows. This is truly an incredible run-up over such a short time frame.

• the compression in corporate bond spreads has help expand the price/earnings multiple and keep the fair-value line trending up.

But Rosenberg thinks the broader market is now close to its ceiling. He wants us to know the world has not suddenly been “fixed;” that our almost-uninterrupted equity market rally lacks conviction:

• The rally’s volume has been weak with institutional players absent from the market, and with very little participation from retail investors. US equity-based mutual funds have recorded 10 months of net outflows, with another $5.4bn in 2012. In fact, there have been no net inflows since 2005 as clients use interim rallies to sell.

• Corporate insiders have been huge sellers of their own stock, exceeding $6bn last month (with the ratio of selling to buying hitting the astronomical 13-to-1 mark).

• The initial public offering market was in a slump during the October-February rally, with merger and acquisition activity sinking to 2008 levels.

• Recent market gains seem linked to the more than €1tn injected into the European financial system.

• Other recent positive economic numbers reflect the warmest North American winter in 50 years, artificially boosting home sales, retail sales, manufacturing, transportation and consumer confidence.

The Ugly. There is mounting evidence that China, the world’s current economic engine, is in trouble.

The Chinese power struggle is now very much in the open. Jamil Anderlini, also writing in the Financial Times, called Chongqing party boss Bo Xilai’s Thursday sacking “the most significant end to a political career in China for more than two decades.” Bo, as Anderlini wrote, is “China’s most charismatic and polarizing Communist official.” Bo’s purge proves there is division at the top.

Established leaders saw Bo as a real threat to their power. Anderlini reports that Xi Jinping, scheduled to be China’s next leader, wrote a strongly worded editorial in the party magazine Seeking Truth that anticipated Bo’s departure. Xi said the party must:
firmly oppose all actions that harm and split the party . . . firmly excise decayed and corrupted people who deviate from the party constitution, who jeopardize the undertaking of the party and who have lost the credentials to be a party member
And the day before Bo’s fall, Premier Wen Jiabao gave a rare, nearly three-hour press conference to conclude this year’s National People’s Congress. In the course of answering press questions, Wen warned:
Reforms have reached a critical stage. Without the success of political reforms, economic reforms cannot be carried out. The results of what we have achieved may be lost. A historical tragedy like the Cultural Revolution may occur again. Each party member and cadre should feel a sense of urgency.
Openly commenting on Wang Lijun, Bo’s top cop until Bo fired him who then fled to Bo’s enemies in Beijing and help trigger Bo’s fall, Wen added China has “taken detours” and has “learned hard lessons.”

China’s leaders prefer to fight behind closed doors, to present China and the world a unified front. Xi, Wen and the other party leaders know their power rests on successful, sustained economic development. Signs of opposition from Bo Xilai and other proto Maoists most likely reflect rising worry at the top that China’s economy is headed downward.

That’s certainly the view of Gwynne Dyer, writing in the Japan Times. Dyer tells us:

• more than half of the 124 skyscrapers currently under construction in the world are being built in China. . . a frenzy of skyscraper-building is also the most reliable historical indicator of an impending financial crash.

• the West wants to believe that China's economy will go on growing fast . . . Twenty years of 10%-plus annual growth have made China the engine of the world economy. . . But the engine is fuelled by cheap credit, and most of that cheap money, as usual, has gone into real estate.

• [Wuhan,] in addition to a skyscraper half again as high as the Empire State Building, is currently building a subway system that will cost $45 billion, two new airports, a whole new financial district, and hundreds of thousands of new housing units. . . Last year Wuhan municipality spent $22 billion on infrastructure and housing projects although its tax revenues were only one-fifth of that amount. . .

• Land in Wuhan has tripled in price during the property boom, and could quickly fall . . . if confidence in the city's future were to falter. [Yet] Wuhan's housing stock is already so overbuilt that it would take eight years to clear even the existing overhang of unsold apartments . . . never mind all the new stuff. Multiply the Wuhan example by hundreds . . .

• Beijing knows that the property bubble is dangerous and is trying to switch spending to consumption. . . there just isn't enough time. . . China is heading for a classic "hard landing", and when it comes, it will slow the whole global economy to stall speed.

• the Communist regime is clearly frightened.

We should be frightened as well. Our economy needs China's to be strong. The ugly.


Derek said...

One could have done quite well in the markets, the last 8 years, by taking the opposite side of every single one of Amity Shlaes' predictions.

Same holds here, I suspect.


Galen Fox said...

Thank you for your comment. I'm largely unfamiliar with her past predictions, but tend not to believe her inflation "black swan" warning.