China Questions
Research for Online Investors

by John Dalt

8/30/11

Something funny is going on in China.  The Yuan has been appreciating faster than in the past, their stock market is not performing as well as other Asian markets, and another interest rate hike looks likely at the end of September.  The recent flurry of accounting problems at Chinese public companies may be catching up with the hot market.

Earlier today, all the Asian markets were up over one percent, except China.  The Shanghai market lost a little and Australia (who is dependent on China for exports) barely recorded a gain. There have been articles and predictions of the “Chinese Miracle” coming on hard times.  The question always seems to be if China can slow their overheated economy with a “soft landing” rather than a recession.

The country has been an economic marvel as people moved from farms to cities.  Cheap labor has fueled manufacturing and export growth.  The Communist government has managed the economy to maximize growth.  Much of the growth has been building out the infrastructure for the large population shift that has been occurring. What happens when all the infrastructure spending slows or ends?  We don’t know, but you can only build so many malls and complete cities only to have them sit empty before you pull the plug on the latest “five year plan.”

We pulled back from investing directly in Chinese companies earlier this year.  There always seemed to be questions and less than satisfying answers.  BYD Co. (electric car manufacturer) reported a drop in first half of year income of 88.6% last week.  Berkshire Hathaway owns 10% of BYD through BRK’s Mid-America Energy Energy Co.

What happens to great U.S. companies like Walmart, McDonalds and YUM Brands if China goes down in flames?  All have big a presence in China.  It is something to consider when looking at potential investments or your present holdings.  The tough thing is that China has become such a big driver of economic growth there are not a lot of safe havens.

When all else fails, stay in precious metals!

Consumer confidence fell to a reading of 44.5; the lowest since Lehman Brothers went bankrupt in spring 2009 and all heck was breaking lose in the mortgage back securities market.  Last month’s reading of 59.5 was revised down to 59.2, but the reading is troublesome.  A falling confidence number could lead to reduced spending if Americans feel uncertain of the future.  The Conference Board’s index also showed that finding a job is becoming more difficult, rising to the highest level since November 2009.

The market reversed this morning to move into positive territory after the Federal Reserve President from Chicago; Charles Evans told CNBC he favored stronger accommodation for a substantial period of time by the Federal Reserve.  Evans said, “It’s difficult to characterize the labor market as anything other than consistent with being in a recession.  I’m in favor of some of the most aggressive policy actions of anyone on the committee.”

That was music to the ears of traders that want to have more money flowing into the system.  Precious metals paused when the market reversed but soon regained their strength from earlier in the session.

Precious metals had become negatively correlated to the stock market in the last month.  They were acting as a safety play for traders, going up when equities go down.  More easy money will raise all boats!  If the market rally fails, precious metals should again act as a safety play.

The Case-Shiller Home price index showed housing prices in 20 cities fell 4.5% from a year ago.

The FOMC meeting minutes from August 9 were released this afternoon.  The Fed discussed additional quantitative easing and shifting their asset purchases to longer dated securities.  We wrote about the funds the Fed is reinvesting every month as existing bonds mature on June 30 in Irrational Exuberance.  The Fed buying longer maturities would keep interest rates lower for home buyers.

The Fed was sitting on $400 billion in cash in June, and brings in about $35 billion per month in interest and maturing securities.  They are still the biggest “invisible hand” in the fixed income markets.  Bernanke told us in June the Fed would continue reinvesting maturing debt in U.S. Treasuries.

Sell into the rally and stay in precious metals!

Mailbag:
We received no really good news this morning, the housing market is still tanking, and we have billions of dollars of damage from Irene. What made the market soar today? Have I missed something?—Buy, Sell, Hold & Long-Term Portfolio subscriber G.C.

John’s reply:  Two Greek banks merged in the hope that two bad banks can make one good bank.  Never worked before, we will see. We think the market was oversold and wanted to rally, but watch volume…it is going down as buyers disappear.  Until we higher volume on up days, the market is in danger of a reversal.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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