As I have touched on before this weekend, things do seem to quickly change behind the scenes in the way the different Asian economies function as systems, and here is the post that will go at it more thoroughly to try to draw conclusions and, from them, trends.
Lets dig in!
1. Bitter Barter?
Asian countries (and territories) at large mutually hate each other. I guess this comes from different periods of being suppressed, growing strong and getting suppressed again throughout the previous century, and a claim to long histories – seriously, it can’t be pretty if you all claim at least 2000 years worth of civilization and “ownership” of the pure, true Han culture – which breeds animosity throughout the region. A dislikes all other letters. B dislikes A and C through Omega C… you get the picture. India is in the ring as well, you know, kinda difficult not to play the card as the world’s second most populous nation and a BRIC member, and part of The Commonwealth.
Given this bitterness, it is pretty encouraging to see it being overcame and more free trade deals being tied, and mutual currency agreements coming around. Smatterings have gone around for some time with Japan attempting to close deals with China, and Korea to an extent, but the news out of Korea this week that the Bank of Korea was granted Qualified Foreign Institutional Investor (QFII, in popular jargon) status to diversify part of their US$311.3 bn currency reserve holdings into Chinese assets is nothing short of massively encouraging. Questionable given the relative performance of their stock markets if much stocks will be bought at the moment at least, but I’ll get to this later. Still, diversifying into yuan-denominated assets could be a great play, given the current account and GDP growth. Wildly bullish for China, and also fairly bullish for the region in general seeing how the investment opportunities overcome the animosity between the states, slowly but surely. Things are simply looking up pretty much here, and given valuations of the Chinese indices and stable (of course!) currency performance, it’s kinda hard to see how this could turn out badly on Korea’s part.
I’m expecting these trends to continue and spur increased monetary interactions throughout the region, adding to the detriment of the US Dollar as a medium of trade. Forecast? Increased chance of money showers throughout the region, with the occasional lightning strikes burning those who are afraid when things get rough and seek shelter.
2. China itself is moving quickly to kill the natural trading in its’ stock market!
Now, please don’t take this at full face value. I don’t mean this in as negative a way as it sounds, but here’s the background to why I chose that heading.
My thesis is that the Chinese economy is one where the (increased) value of headline housing, and stock market index prints is entirely irrelevant as far as the government is concerned! How’s that for putting this blog out for some heat economically? The reasoning goes that the people that can really afford to buy houses and stock – which are your only investment opportunities outside of physical precious metals – for any intended holding period shorter than say 5 years, are in fact rich. Surely it will hurt a bit to see spending from these people fall away, but trust me, Chinese people like money for the value of money, and if you see them truly spend it, they are indeed filthy rich, US$ multimillionaires and above. There’s very little of the conspicuous consumption chain that is so relied on in the US to help the case of the Chinese rich from a regulatory or political standpoint.
Consumer spending will instead happen in the country once it’s further taken out of poverty by spreading the wealth further inland, to first allow the farmers and rural villagers to first meet more of their needs, and some of their wants, and then build steady nest eggs, before consumption can kick in in any wider respect. Now you have why overhead GDP growth numbers are insanely important, while the (wildly reported 70 biggest cities) housing prices and stock market prices could, for all the government cares, hit rock bottom. They’d rather see that being spent on internally produced goods to spread wealth further inland. This is also why the insanely fast rate of industrial wage appreciations of 15-25% on the lowest salary levels in the eastern seaboard – the Pearl River Delta, Shanghai region, and somewhat further north – is so good: it encourages the migrant workers who make up that pool of workers to send more money back to the rural hinterlands, and potentially provide start-up capital for the workers themselves for any return where they apply business ideas they have been exposed to in the more developed eastern seaboard. The structure of migrant workers and to an extent the complex Hokou system that ties people to their birth lot thus works together to create a conduit for cash and business insights to be funneled further inland. Mind you, I am not endorsing the Hokou system, I think it will do China a lot of harm in the long run and it better be adjusted pronto, but that will not prevent me from discussing or even applauding some of the few good things about it.
In reading the paragraph above, note the importance I placed on the nest egg. The Chinese are very dedicated savers generally, and consumption is not high on the list in the long run. this is often due to the enormous shouldering of potential costs that one has to take into account that this nest egg will be needed for: spending on your children like buying them a home (if they’re boys they’ll need one of these before they’ll marry, or for your family to upgrade their current one to include his wife) and education, any unforeseen costs like healthcare will be shouldered by yourself since the insurance industry is not there, and of course retirement to the extent that your children will not provide for you. The social contract so widely held in the west (work hard yourself and invest the proceeds of this work with the younger generation in general so that they can provide return on investment and result in pensions, and pay small pooled fees for insurance against improbable events) is not there in China, and neither are capital markets for yield return, so vast nest eggs are needed. So far, the workaround for a low salary that prevents building nest eggs has been to work hard until you cannot anymore, and from then on rely on your children, and that’s why boys are so favored. Were this to change, nest eggs will still likely be big, since there is certain cultural pride in self-reliance and financial success (which is not interchangeable with successfully attaining a loan), but they can come down. In a positive spin, the generational gap that is prevalent in mainly the US and Japan where the pension system provides a lot of unfunded liabilities for children to necessarily pay off later is not there either.
Put together, the structure of money in China, and the available markets at large to a large extent prevents money from circulating like it does elsewhere, and creates a lot of incentives for the working Chinese thinking about starting a family that to a westerner would seem absurd. Well, enough of the social problems: my main point is that it creates a very fundamentally basis stock and property market. Supply gets reflected quickly in demand, but the money is not needed to fund bigger ticket items, so these markets are fueled by discretionary money and therefore become highly speculative. More return leads to more demand which leads to more return, until a bubble comes in and the state can quickly see this and try to smooth it out without too much social problems coming in. Chinese people are thus not overly exposed to equities they have not picked themselves!
This contrasts with the developed world where some of the biggest financial players are the pension funds and their impact on the market can lead to impressive swings, explicitly seen in stock prices if they’re included or excluded from benchmark indices. For example, one of the main potential contagion effects widely discussed around the August budget/downgrade ruckus in the US was the impact on pension- or insurance funds that were legally required to hold at least a given portion of AAA paper! Stock market ramps and economic growth in the 5-7% range in perpetuity represent the promised holy grail of the worker in the west, knowing that his portfolio can safely reflect 50% of stock returning 8% a year and 35% bonds at 5% to allow a house and a US$50-100K portfolio to stand him in good stead for his old age. Japanese retirees by contrast have vastly more saved up, but pretty much rely on the paltry 0.95% or 1.9% yield in government bonds (10Y and 30Y respectively) plus expectations of mild deflation to provide for them. Then, because the bonds are used by so many people seeking safety, they rise up abnormally and yields are the lowest in the world even though the sovereign debt market is on the verge of not maintaining A-band status with ratings agencies!
Any questions on why anything less than 5% growth in the west leads to great misery, or why 10Y yield in Japan is below the 1% mark?
I might be brewing a storm in a glass of water here, but that’s a pretty interesting indication that China is going to great lengths to open up their capital markets and scrub the mark of impoverished tradition from their society. Pension funds and insurance schemes coming to market and trading venues checked out more closely are great news. Expect the days of substandard stock market valuations relative the West to be gradually a thing of the past as immense floods of money pours into the market over the coming few years (probably somewhere around the 5-10 year mark in earnest, given current growth, but just the green lighting of something like this should send the market higher). Compare the Chinese growth at 9-10% (leading to an increase of roughly 50% since 2008) with the Shanghai Composite performance! Four years, 50% growth, and the stock market is down 30%, or 60% from peak! Sure it was bubbly and speculation driven, and a lot more companies have came to market, masking the index indication of economic growth, but let me ask you where else this would not be labelled as total economic malaise and purging death to investors? In around the 5-year mark when the Chinese economy is likely to be roughly 50% bigger – 8.5% growth compounded – and perceived success of pension funds, insurance schemes and capital markets allows a certain wider sense of trust to be placed in them, expect a wide inflow into these areas and the proceeds to gradually spur consumption, which would boost the economy, which would lift market valuations further, and repeat. Calling it right now: economic structural shift in China leads to massive stock market bubble crash in 2026!
In the meantime, this just adds to the flood of money that should be ready to enter the stock market in the coming half a year, and for another ten years, there will probably be a pretty good structural China case that will do the country and culture good, which will demonstrate itself relatively much better in equities! Enjoy the buy and hold lullaby for another 5-7 years (possibly ten, but then it’s fishy), and then go into trading like a madman on the swings and bubble scenario building as capital markets bloom and provide a trader’s wet dream! How’s that for permabullish?
3. Japan looks increasingly like it has dropped the weak yen policy.
As I mentioned earlier in the first post this Satuday, I believe that the yen is likely going higher for a lot of reasons, including silencing of a policy cacophony on intervention in the currency markets or central bank intervention, or the fact that Japan is a lot bigger than Switzerland and that policy intervention is therefore a lot more tricky to execute without massive losses.
It can be inferred from my pension scheme importance discussion above that I fundamentally believe this to be a good thing. I definitely believe that Japan is currently on the pivot point of what could be immense economic growth where most of its positive aspects come to light on the one hand, and on the other economic upheaval leaving a declining birth rate with a titanic burden on further generations that will lead to massive defaults and misery for a few years before the system is rebuilt from the ground up to actually make use of the country’s positive aspects.
Say that the currency appreciates, leading to imported goods getting cheaper and some exporters getting squeezed tighter (1-3 year time frame), forcing exporting corporate cuts and adding deflationary pressure. In the short term, this looks good for pensioners as their saved yen goes a long way further, and the possibly continued yen-denominated current account deficit isn’t that big of a deal. If this squeeze could just be tight enough, and the increase of the currency value makes it an attractive place to invest where internal consumption is relatively unscathed allowing one to profit from stocks of consumer goods producers and capital reallocation to new ventures, then I firmly believe that Japan would be in an unprecedented sweet spot. As this process continues for a while, it could very well set of a chain of events that allows Japan to experience the equivalent of the US 80’s when the currency was rallying strongly and the stock market started levitating as enormous amounts of capital started flowing in. This chain of events could be greatly aided by any developments in China that follows the discussion set out above.
If the tax rates slowly start rising, and savings rates remain relatively high but new capital procured from any growth is predominantly placed in riskier assets, then hopefully Japan could see inflow of private equity money that looks to make great use of some of the brilliant ideas squirreled away in Japan and not used elsewhere or to their full potential even in Japan, which could set in motion a great basis for another firm run upwards in all things Japanese. Positively enough, the Japanese government has for some time now been pretty friendly to private equity, and hopefully the yen appreciation potential and massive deposits held in Japanese accounts looking for yield could both make the suitor look a little bit better, and allow the flirts to be reciprocated!
Hope you continue to have a good weekend, I certainly had while writing this!