Last week, I put out a few year-end predictions on where I thought select market indicators would be. Perhaps I should have expanded that game further…
If someone were to have asked you last week (at year-end), are equities rich or cheap to valuations? I’m pretty sure most people would have said “rich.” Because whether you look at cash flow, earnings, P/E, or whatever your favorite metric is, we were very close to historical levels of richness, in an environment that does not foster great optimism. So is it really any surprise that equities came off? I predicted only a 2% median drop by year-end (with an associated larger downside tail), because companies and 401(k)s keep buying equities. I posited last year that that 1800 would not be an unreasonable valuation for the S&P. A correction doesn’t mean the world is coming to an end – it’s just part of the normalization.
Another question: if someone were to have asked you last week (at year-end), where will the yuan be at year-end? I fail to see how everyone wouldn’t say “weaker” relative to the USD. CNY has been weakening relative to USD for the better part of the past 18 months. And just from interest rate parity, you should expect the USDCNY level to go higher. To get to 6.75 or wherever higher level, USDCNY is going to have to take a few jumps here and there – especially if they are eventually going to ease currency controls. Was the FX move a “sign” of bigger things, or just another step towards normalcy?
Here are some more of my simpleton views on China:
- The Chinese economy is still growing overall. Not at 7% (as reported), but still north of zero. If it is north of zero, that means things are still humming – more jobs, more sales, etc. Manufacturing may be below zero, but the Chinese economy is also evolving. There was an interesting graphic on the WSJ last week on how there has been a shift in the composition of wealthiest people in China in just the past 5 years. Just as the US has moved on from agriculture to manufacturing to service, the Chinese will do the same (but in much faster time). Don’t keep expecting China to continue to focus on manufacturing.
- China has money. We’re not talking about some broke country like Greece ($5.5 billion in reserves). China has over $3 TRILLION in reserves. The next largest country is Japan with $1.2 trillion, and our USofA has $0.12 trillion. So are we really concerned about a country with almost 30x as many reserves as us? The burn rate is high, but that’s why fx adjustments need to be made. At some equilibrium point, the burn will flatten out.
- China has different channels of power. One thing that was clear last year is that things in China don’t work the same as in the US. In the US, if there is a crisis, people start running around like headless chickens, checking with people in other organizations, arguing in subcommittees over who has jurisdiction and what should be done, whether any laws or rights are violated, etc. It really is amazing anything gets done. There, some guy in charge eventually just says, “this is what we are going to do,” and that’s what happens. Market rules get changed overnight, people get sent to prison, whatever it takes. Some company can’t pay? Welcome to the world of state-owned enterprises. Not every decision is a good one, but adjustments are made just as quickly.
I’m not saying China couldn’t go into a recession/depression. It’s just that you need a lot more to happen before we get there. Until then, all I see is a stock market bubble being popped – a stock market that is still up 50% in the past 18 months, and which may still have some more downside. But that does not concern me as much as it did last year.