Chinese economic numbers have about as much credibility as Noah Cross, the villain in the movie Chinatown. The character is based upon the real-life first superintendent of the Los Angeles Water Department, William Mulholland.
Mulholland is alleged to have lied to, cheated and threatened the farmers and ranchers of the Owens Valley, which was then called “the Switzerland of California,” thanks to the abundant snow runoff from the Eastern Sierra. He promised that only a small amount of their water would be diverted via a grand project that became the Los Angeles Aqueduct.
In fact these residents were merely pawns in the game to turn the near-deserts of the San Fernando Valley into an oasis of agriculture and commerce. All their water was taken from them, resulting in the dry lake bed that has replaced Lake Owens and the subsequent desert that replaced grazing and farming lands, both results on display today as one drives from LA to Bishop or Reno along Highway 395.
As these rural residents lost not only their livelihood but came close to losing their means of survival, Mulholland’s provocations became more intense. The result was the biggest of the California Water Wars. When the press and the state politicians refused to sanction any more abuse of these citizens, Mulholland was quoted as saying that he "half-regretted the demise of so many of the valley’s orchard trees, because now there were no longer enough trees to hang all the troublemakers who live there."
Mr. Mulholland met his own "Water-loo" just a few short years later when a huge dam, which he had personally inspected and declared safe only 12 hours prior, burst and collapsed, spilling a torrential river 140 feet high into the valleys below. In addition to the untold physical destruction, more than 600 people were known dead, including over 100 children, most buried in mud or swept into the ocean.
What does this have to do with China today? Noah Cross was an autocrat, an elitist and a narcissist. Autocrats, elitists and narcissists make lousy investment partners. They lie when they need to in order to maintain whatever facade they are trying to project. Right now China's autocrats desperately need to project an image of continued growth. To claim 7% growth would have been a laugh. To say 6.5% would have induced panic. They finally settled on 6.9%, knowing that was higher than the regularly revised downward estimates of Western analysts.
I can see them in their smoke-filled chamber trying to decide what number to use. They had to choose one that wouldn't force them to stimulate the economy with a greater loss to the treasury, but would placate potential foreign investors. I believe the number is compiled for political release and has nothing to do with the real state of production in China.
Why? Because it doesn't tally with what we are seeing from nations and companies doing business with them. Alcoa (N:AA) just announced, based upon advance orders, that it projects vehicle production in China to rise 1-2% this year. That's down from 5-6% just 6 months ago. What a stunning reversal! Brazil's iron ore companies have been steadily selling off as Chinese infrastructure invest abates. Does anyone really believe China has stockpiled enough iron ore (at much higher prices) so it can still continue building gargantuan, state-sanctioned projects to “transform” their nation in a giant leap forward without iron, steel and aluminum? In fact, crude steel production actually declined 2%over the past 8 months.
Capital Economics' analyst Julian Evans-Picard echoed Credit Suisse and other skeptics when he wrote recently regarding the current numbers:
"Unfortunately these numbers have to be taken with a grain of salt...our China Activity Proxy [Ed: a proxy used to measure actual numbers from Western firms showing demand for raw materials as well as independently verified numbers for key sectors within China] suggests that a drop-off in fiscal spending due to new budget rules caused growth to slow sharply from around 5.5% in Q42014 to around 4% in the first quarter of this year."
China reported that Q4 2014 was 7.2% and Q1 2015 was 7.0%.
Even China has said now that it will lower its target growth rate for the 13th five-year plan to 6.5%. What does the film Chinatown have to do with China today? On the surface, not much. But deep down, where it really counts, maybe more than they are letting on.
Emerging Economies / Frontier Economies
Of course, weakness in China does not bode well for the emerging markets that typically supply the raw materials for China's alleged outsized growth. They're already on the ropes, so any further decline in demand from China might KO them.
Given that emerging markets have dropped some 28% in the past year, many investors are ready to begin buying. At single digit PEs after such a decline, a lot of folks find the valuations compelling. We are not among them.
Some emerging markets are transparent, like India. (India is a cacophony of dissonance and a jumble of regulatory and cultural hurdles but at least it is transparent!) Most, however, are more like China and Russia, where the average citizen is denied opportunity, almost all decisions are made by a few at the top willing to toe the party line, and where the only numbers you can trust come from your own analysts. Whatever the government claims is said for political expediency, not for economic truth-telling.
We avoid even more scrupulously the “frontier” markets and for much the same reason. Myanmar, Vietnam, Guatemala, Mongolia et al are enticing for some; It’s cool to imagine being the first to invest in such places with dreams of untold wealth as others follow the path they have marked. I have three words for such dreamers: Don’t Do It.
Take Myanmar, which I will refer to as Burma since that is more inclusive of the 135 distinct ethnic groups in Burma than the Burman (Burmese) word Myanmar. I was an air attaché there in the 1990s and have followed the careers of some of the majors and lieutenant colonels I knew then who later rose through cunning, guile and brutality to become the leadership elite of the country.
It did not particularly surprise me when, in 2005, these paranoid autocrats decided, with no warning, to occupy a new capital 200 miles north of Yangon (Rangoon) and force the civil servants that keep the country running—to the extent that it does—to follow them within 48 hours. For all I know, then-strongman Than Shwe, always a sucker for a good astrological forecast, decided to heed one of his soothsayers.
The point is, when you invest somewhere with a capricious-at-best rule of law, with limited or no transparency and a completely different set of cultural biases, interpretations of morality and mortality, and ethics, you deserve what you get.
So Much For What to Avoid. Now — What Are We Buying?
Since my last article, we have re-purchased Direxion Daily CSI 300 China A Share Bear 1X ETF (N:CHAD) and ProShares UltraShort S&P500 ETF (N:SDS) and added new purchases of ProShares UltraShort MSCI Emerging Markets ETF (N:EEV).
For clients with a more conservative portfolio, rather than hedging to make a profit on any decline, we are trying to buy great preferreds that tend to move only a few pennies a day no matter how volatilethe markets.
The problem is that many of these are really lightly traded so a bid-ask of 24.45 / 24.65 is not unusual. Even if we were to pay the asking price, the moment the first couple hundred shares execute, the ask moves up to 24.75 or 24.80. We are patient investors,however; we’ll get more of these over the coming weeks. Among those we’re actively trying to gain positions in are Cullen Frost pfd A,HSFC (HSBC Finance) pfd B, and of course all our different PSA series preferreds that we’ve discussed previously, as well.
Finally, for the third leg of our triad, we have entered some opportunistic, well below the current price, orders on crème de la crème companies. I don’t “expect” another 1000-point flash crash that then recovers but if it happens I won’t mind profiting from it by initiating positions in superb companies at great prices and holding them for the future. Among these are some names well-known to all investors, like Apple (O:AAPL), Disney (N:DIS) Exxon Mobil (N:XOM), and Chevron (N:CVX). To this short list I recently added Gilead (O:GILD), Spectra Energy (N:SE) and Caterpillar (N:CAT).
If we get them, it’s a gift in the middle of what would otherwise be a catastrophe. If we don’t, we may still buy them there after a steady drip, drip, drip decline. As always, do your own due diligence!
Disclaimer: As Registered Investment Advisors, we believe it is essential to advise that we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management,and should not be construed as "personalized" investment advice.
Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded! We encourage you to do your own due diligence on issues we discuss to see if they might be of value in your own investing.
We take our responsibility to offer intelligent commentary seriously,but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right,and we "eat our own cooking," but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.