Friday, April 29, 2011
Wednesday, April 27, 2011
In a related article entitled Leveraged ETFs: A Look at a Play on the S&P 500, we compared the relative performance of the Proshares S&P 500 ETF (SPY) and the Proshares Ultra Short S&P 500 (SDS) when funds are held for different time periods. The results were astonishing: if held for only one day, tracking was almost perfect; over a month period, slippage was about 1%; over a three-year period between April 12th, 2008 and April 11th, 2011, the S&P 500 Index lost 1.5% of its value; the twice bearish SDS fund was down 66% implying a loss of 69%.
Read the full article here.
Tuesday, April 26, 2011
Sunday, April 24, 2011
Friday, April 22, 2011
Paul Kutasovic, Ph. D.
Panos Mourdoukoutas, Ph. D.
The post-bubble regime characterized by slow economic growth, high unemployment, rising trade frictions, government re-regulation, and consumer deleveraging in the US and Europe will test many policies and institutions launched in the pre-bubble regime characterized by high economic growth, trade liberalization, government regulation, and consumer leveraging. China’s export/imitation led industrialization is one of these policies.
In the aftermath of the bursting of the US residential real estate bubble, virtually every country in the world economy has endured either a serious slow-down or a deep and prolonged recession. And while a massive monetary and fiscal stimulus has helped most economies improve, the world has now entered a period of slow growth, which fundamentally changes the rules of the game for every country including China.
For almost three decades-the pre-bubble world, China’s entry into the world economy coincided with rapid economic growth driven by the spread of world economic integration and robust consumer spending in Europe and the US. Exports and external demand has been the engine of growth for China, as rising exports boosted industrial production and encouraged business investment. As China became the world’s factory, robust manufacturing led to surge in employment and income, feeding into a “virtuous cycle” of multiplier and accelerator effects.
In the post-bubble world, which began following the financial meltdown in September 2008, world economic integration and international trade has slowed substantially. Export growth fell in almost every country resulting in large declines in GDP, especially among the trade dependent economies of Asia and Europe. China’s export outlook for the next several years is not expected to be as bright as it used to be, as the outlook for economic growth in China’s largest export markets the US and EU remains uncertain. The early 2010 debt crisis in Greece and the slowdown in Germany are especially worrisome for the prospects of a meaningful revival in global trade.
But even if the global economy resumes growth, the days of rapid export-based growth are likely over. The Chinese strategy by and large was based on imitation and the mass production and exporting of products developed elsewhere. While this strategy worked well in an expanding world economy, it faces significant hurdles in a sluggish global economy that is expected to fuel economic rivalry and trade friction. This point is highlighted by concerns in the US over sluggish job growth and a growing emphasis in the Obama administration toward a policy of export-oriented growth as a major component of a solution to the jobs problem. To continue its rapid accent, China must shift from an export/imitation strategy to a domestic/innovation driven one that requires the launching of an aggressive socialist agenda that revises many of the country’s institutions.
Arguing this contention, the remainder of this paper is three sections. The second section is a discussion of China’s economy in the pre-bubble economy. The third section is a discussion of China’s post bubble economy, while the fourth section concludes the discussion.
2.0 China in the Pre-Bubble Economy
The pre-bubble world, especially the 1978-2008 period, which coincided with China’s rapid industrialization, was an era of fast economic growth driven by trade liberalization and government deregulation that turned the world economy into a global market. From the 1970s to the mid-1990s, world merchandise exports rose from 11 to 18 percent of GDP, and service exports from 15 percent to over 22 percent, while sales by foreign affiliates exceeded the world’s total exports. Foreign direct investment outflow rose by 28.3 percent in the period 1986-90 and by 5.6 percent in the period 1991-93.[i] Globalization accelerated in the mid-1990s as the diffusion of information technology, growth of the Internet and the creation of the World Trade Organization and the North American Free Trade Agreement reduced trade barriers and expanded global trade.
China’s growth since the 1978 reform has been in a league of its own significantly exceeding even the rapid rise of the Japanese economy during the 1950s and 1960s. Since 1978, annual GDP growth has averaged more than 9.5% (Table 1).
China’s Growth 1978-2009
| || |
Source: National Bureau of Statistics of China, Various Years
China’s growth was driven by high rates of investment with investment as a share of GDP exceeding 40% in recent years. This has raised concerns about levels of excess capacity in many industries and low rates of return on the investments. Another important feature of China’s growth has been the rapid growth in industrial production.
Industrial production has increased at an annual rate of nearly 13% since 1978. In 2008, industry contributed nearly 65% to GDP growth compared to 6 percent for agriculture and 29% for services.
Like Japan and the Asian newly industrializing countries, China pursued an aggressive export-led industrialization policy based on imitation, the low cost replication of foreign products; a strategy supported by a host of reforms that loosened the grip of central planning on the economy. In the manufacturing sector, for instance, initial reforms allowed a limited number of enterprises to market their products outside the central plan directives, make personnel decisions, retain and reinvest profits, and set their own bonus and welfare payments system. Subsequent reforms expanded this program to the entire SOE sector and changed the tax law to give SOEs a number of write-offs and depreciation allowances, switching the financing of SOEs from outright grants to loans connecting corporate financing to creditworthiness. More recently, reforms gave SOEs the authority to adjust inputs and outputs to changing market conditions, recruit middle level management, and retain and distribute realized profits.
Resisting pressures for exchange rate appreciation, the export-led policy has resulted in growing current account surpluses and a surge in the accumulation of international reserves. The current account surplus now exceeds 12% of GDP and holdings of international reserves are now approaching $2 trillion. The growing trade surpluses are raising trade frictions among China’s trading patterns and the growing holdings of international reserves are increasing the monetary base and fueling a credit expansion that feeds into financial bubbles, massive construction and manufacturing projects for the purpose of employment creation rather than for serving consumer needs. Major Chinese cities are crowded with growing numbers of new buildings built under government mandates to provide jobs for the hundreds of thousands of people living the countryside for a better life in the cities, rather than to house genuine business tenants.
Bubbles are also evident in other sectors of the economy, from the steel industry to electronics and toys industries. The problem is that more and more Provinces rushing to copy each other, especially those of the inner country, where managers having no direct access to world markets assume that it is prudent just to follow the policies of their peers of the coastal provinces. This became more evident in the aftermath of the Asian crisis, when economic growth slowed-down considerably and it became increasingly difficult for State Owned Enterprises (SOEs) to maintain staff levels or to provide employment for newcomers.
China’s rapid industrialization has further taken its toll on the environment, as it graphically described in a number of books and newspaper articles. In The River Runs Black, Elizabeth C. Economy describes the destruction of Huei River, a source of life for people living in Huei River Valley. “At first glance, China’s story appears to be a classic tale of economic development run amok. As China has moved to a market economy, freeing its economic actors to make money and exploit the country’s natural resources without penalty, it now confronts an environmental crisis.” [ii]
China’s rapid growth over the last 30 years while impressive, it is prone to bubbles, and threatening to pit the country against its trade partners and against the environment. The sustainability of China’s growth is now the issue, especially in the post-bubble economy.
3.0 China in the Post-Bubble Economy
The post-bubble world is likely to be an era of slow growth driven by trade frictions, government re-regulation, and deleveraging that will restrain the growth of globalization and international trade. Even before the burst of the bubble, globalization no longer seemed a universal trend, for several reasons.[iii] First, economic integration has advanced in different gears across world regions and countries. Economic integration advanced on a high gear in countries like Ireland, Finland, and Switzerland, and in a low gear in countries like Israel, Spain, Portugal, and Greece; while integration has suck into the neutral gear in many African and Southeast Asian countries that continue to remain on the sidelines of the global economy.
In 2005, market opening reforms were concentrated in 26 OECD countries and in 25 East, Central European countries, and former Soviet Republics. For the period 1990-2001, EU(15) accounted for 60 percent of intra-trade in merchandise imports, NAFTA(3) for 40 percent, and ASEAN (10) for around 22 percent. Reflecting such a clustering of trade, most large companies conduct their business in these three areas.[iv] In the early 2000s, Singapore’s and Hong Kong’s merchandise trade (exports plus imports) account for about 150 percent of GDP compared to Pakistan’s 20 percent. As of 2002, close to 60 percent of world trade was concentrated among ten countries; and 33 percent among three countries, the US, Germany, and Japan.[v] Ten countries received 80 percent of global investment flows, while the majority of cross border acquisitions occurred in high income countries, most notably in the US, Canada, France, and Germany; 84 percent of newly acquired or established US multinational affiliates were located in developed countries.[vi]
Second, economic integration has advanced in different gears across industries. Economic integration is shifting to a higher gear in textiles, as a 1974 trade pact expires, eliminating a number of quotas and tariffs that limited the flow of garments from developing to developed countries. Economic integration is also shifting to higher gear in services that have become the target of a new wave of outsourcing. Globalization remains in low gear in a number of industries that continue to be dominated by “local clusters,” geographic concentrations of companies related by common skills, technology, inputs, regulatory framework and culture, like those of Silicon Valley, Napa Valley, Hollywood, and Sanjyo’s (Nigata, Japan). Commodities and resources cannot flow freely across markets, and location continues to be a source of competitive advantage. “Paradoxically, the enduring competitive advantages in a global economy lie increasingly in local things-knowledge, relationships, and motivations that distant rivals cannot match.”[vii]
Economic integration has shifted to the reverse gear in a third group of industries that have regressed to trade protectionism and government regulation. The steel industry is a case in point. In December 2001, citing a surge in imports in 12 steel products, the US imposed ad valorem duties ranging from 8 to 40 percent, and tariff-based quotas up to 20 percent. The food industry is another case in point. The EU has ban genetically engineered altered products that hurt American farmers, while the US requires producer registration and early import notification slowing the flow of goods in local markets. Compounding the problem, concerns over the spread of terrorism has slowed-down the flow of resources and commodities across national borders.[viii] Business travelers take longer to obtain visas slowing-down trading in sophisticated equipment like aerospace products, metal cutting machines that must be inspected by customers before shipment. Some observers reach as far as to declare the end of globalization.[ix]
As economic integration shifts to different gears across industries, so are trade flows. The World Trade Organization (WTO) reports that for the period 1990-2001, exports of industries at the center of trade liberalization like machinery and transportation equipment, and office and telecom equipment have experienced the highest growth, while exports of industries still under protection like food and industrial supplies have experienced the slowest growth. The 2001 Economic Report of the President (USA) finds that capital goods, consumer goods, and auto parts are highly globalized while industrial supplies and food sectors are less globalized. US capital goods imports, for instance, increased from 23 percent in 1989-90 to 28.2 percent in 1999-2000, while exports increased from 37.8 percent to 44.8 percent. Food imports increased by 5.2 percent in 1989-90 and 3.9 percent in 1999-2000, while exports increased by 9.4 percent in 1989-90 and 6.3 in the period 1999-2000. Trade flows have shifted in a lower gear in less globalized industries, such as repair and maintenance services, credit origination services, entertainment, and medical care services that are localized. For the period 1990-2002, the share of transportation and travel service exports has declined while the share of other commercial services has increased. Global trade in services has declined by 1.3 percent, while global FDI dropped by 53 percent. In 2001, global merchandise trade slumped by 43 percent to $6.08 trillion, the first decline since 2001, dragged by a decline in IT trade, which accounted for 60 percent of that decline.
Third, international businesses continue to face local consumer diversity. For many products, consumers retain their preferences even within highly integrated regions, such as European Union, NAFTA, and APEC. The preferences of Greek consumers, for instance, are different from those of other Southern Europeans, and most notably from those of Northern Europeans; and the preference of Mexican are different than those of Americans and Canadians. The preferences of Asians differ from those of both Europeans and the Americans, even for brand name products, such as cigarettes.
The trend towards semiglobalization has accelerated in the post bubble economy, as American and European consumers deleverage, and economic growth has slowed substantially. In 2009, the US and eurozone economies economy contracted by 2.5 and 2.2 respectively, while Germany contracted by 4.9 percent. Economic growth is expected to resume in 2010, but expected to be anemic at best, especially for the eurozone that is battered by sovereign debt crises.
The rise of semiglobal economy, the shock from the financial meltdown that hit the US and Western economy beginning in September 2008, and the subsequent worldwide recession had a significant negative impact on the Chinese economy As a result of the dramatically decline in global trade, GDP growth in China slowed sharply in late 2008 and in the first half of 2009 .
In response, the Chinese government enacted a massive fiscal and monetary stimulus. In the first half of 2009, investment by state-owned enterprises surged 41% and the total size of the fiscal package was $1.2 trillion, or 13% of GDP, dwarfing the $700 billion US fiscal stimulus package as a percentage of GDP. In addition to the change in fiscal policy, the Central bank of China eased monetary policy resulting in a surge in bank lending. In the first half of 2009, new bank loans increased by a record $1.1 trillion, causing a massive expansion in bank balance sheets.
Growth has rebound strongly and exceeded expectations. GDP increased at an annual rate of 10.7% in the fourth quarter of 2009 compared to 9.1% in the third quarter. Overall, GDP grew 8.7% in 2009 compared to 9.6% in 2008 and 13% in 2007. Going into 2010, the Chinese economy has strong momentum with robust growth in fixed investment and retail sales. Government spending on infrastructure, which was a significant driver of growth in the fourth quarter of 2009, will continue to increase in 2010. Nevertheless, growth is likely to slow in 2010 as Government officials have raised concerns about the potential for overheating in some sectors of the economy. Reserve requirements have been raised and banks have been officially requested to slow lending.
Industrial production rebounded strongly with production in December up 18.5% from the level a year ago. Automobile production has been a bright spot with auto sales in China exceeding those in the US, making China the world’s largest auto market. The problem is that production is too dependent on the government stimulus, in particular spending on infrastructure.
China’s trade sector improved in the final quarter of 2009 and through February of 2010 and export rose strongly on a year-over-year basis. But the strong growth in exports is misleading since it reflects growth over the very low base of a year ago. Exports at that time were depressed by the global financial crisis.
Going forward, weakness in global growth and slow spending by US consumers will restrain growth. Thus, China’s challenge is to maintain high rates of economic growth without depending on exports. The smaller trade surplus in February is encouraging and the rapid growth in imports in recent months is an indication of shift in growth toward domestic demand.
The recent performance of consumer spending measured by retail sales is very encouraging. Total retail spending on consumer goods in February 2010 surged by over 30% from its level in the prior year and in all of 2009 reached a level of 12.53 trillion Yuan. Other data on home and car sales confirm the strength in consumer spending. Auto sales for 2009 were up over 40% reaching a level of nearly 13 million units. The rapid rate of growth in retail sales shows the strength of domestic demand, which is also putting upward pressure on prices.
As long as China remains stuck in the export-led growth paradigm, their economy is vulnerable to external shocks and over dependent on growth in the US and Europe. The problem is that growth prospects and trade opportunities in both the US and Europe look anemic over the next few years. Europe faces the prospect of significant fiscal drag due to the need to reduce the size of its budget deficits in order to meet the requirements of the Maastricht treaty. The US economy is undergoing a structural change from an economy heavily reliant on consumer spending, to one where business investment and exports are the drivers of growth. In the pre-bubble economy, consumer spending as a share of GDP in the US increased to an unsustainable level of nearly 73% well above its historic norm of around 67%. A return to its historic norm will result in less spending and borrowing and more savings. This shift will restrain the growth of US imports especially those from China.
4.0 Summary and Conclusions
To maintain its rapid rate of growth over the next decade, the Chinese economy must undergo a fundamental transformation and become a consumer of goods and not just a producer of goods, as Japan did in the 1980s. This will require a significant expansion of consumer spending as a percentage of GDP. To expand domestic demand, China must create a social safety net that provides for the poor and the needy, the sick and the unemployed, convince its citizens to save less and spend more. To promote innovation, China must develop and nurture two important human resources, entrepreneurship and management by creating a business friendly regime that releases the ingenuity and creativity of the Chinese people, their quest to better their own lives, and the lives of their fellow citizens in the process. [x]
China must get the cocktail of free markets and government right, deploying each institution in areas of the economy where it excels.[xi] Free markets are needed to develop the productive forces of the economy, the discovery and development of new products and to take care of citizens’ private needs. In addition, the government needs to manage the social relations of the economy, to address the common needs of the people and reduce social uncertainties that constrain and limit consumer spending.
Some China experts are already optimistic that the country is moving in the right direction, as Chinese enterprises have capitalize on the global slow-down to enhance their global relations, become bigger and leaner. “In general, the 2008 global economic crisis enhanced the position of Chinese companies and their relationships with overseas enterprises, making them much stronger-and presenting a new sort of challenges to other global companies. The next ten years will see the emergence of a new generation of Chinese companies, bigger but leaner, better able to compete and prepared to operate on the global basis.”[xii]
Paul Kutasovic is Professor and Chair of the Department of Economics and International Business at New York Institute of Technology, New York, USA
* A longer version of this paper was published by the China's Foreign Language office, both in English and in Chinese.
* A longer version of this paper was published by the China's Foreign Language office, both in English and in Chinese.
Panos Mourdoukoutas is Professor and Chair of the Department of Economics at C.W.Post Campus of Long Island University, New York, USA.
[i] OECD Economic Outlook, OECD, Paris, 1996.
[ii] Elizabeth Economy, The River that Runs Black,: The Environmental Challenge to China’s Future, Foreign Policy Council, 2008.
[iii] Panos Mourdoukoutas, Business Strategy in a Semiglobal Economy, Sharpe, Inc., Armonk: New York, 2006.
[iv] Peter Gwynne, “The Myth of Globalization,” MIT Sloan School of Management Review Winter 2003, p. 11.
[v] World Bank report Doing Business in 2005
[vi] Raymond J. Mataloni, Jr. “US Multinational Companies,” Survey of Current Business, July 2000, p. 28.
[vii] Michael Porter, 1998.
[viii] Iritani (2003), p. A.1
[ix] For some compelling arguments, see Alan Rugman, The End of Globalization, New York: AMACOM, 2001.
[x] Panos Mourdoukoutas, “China’s Challenge: Entrepreneurship and Management, “ Barron’s, February 4, 2004.
[xi] Panos Mourdoukoutas, “A Dangerous Cocktail,” July 25, 2005.
[xii] Edward Tse, “ The China Challenge,” Strategy and Business, issue 58, Spring 2010.
Tuesday, April 19, 2011
Monday, April 18, 2011
Don’t Count on a FED Put to Save the Stock Market
Complacency is dangerous, especially in a rapidly changing world. Back in 2007, when real estate began to crank, I did have an interesting discussion with a hedge fund manager. “I’m concerned about home prices falling and taking the economy and the stock market down, John,” I said. “You are worry too much,” he replied. The FED won’t let it happen. It will cut interest rates, and home prices and markets will resume their ascend,” John argued in an assuring voice. “Bank of Japan drove interest rates down to zero, and it didn’t work, the Japanese stock market is 80 percent below the 1989 high,” I explained. “Japan is different than the US,” John continued. The rest is history.
I am not sure whether John is still in business and has learned any lessons from history, but many investors seem to have missed it. Anytime, energy and material prices pull back, they do jump in to buy more shares. And when someone raises the question as to how energy and materials can continue climbing at these prices, the answer is clear and loud: “The economy will pick up; and if doesn’t pick up, the FED will continue to print money.” The market goes up in either case! According to the AAII survey, in the first week of April, 43.6 percent of investors were bullish, while 28.8 were bearish—near the 2007 levels.
I hate to spoil the party, but I must remind investors that we don’t live in paradise where economic resources are free and God takes care everyone’s need. We do live on planet earth where people are faced with scarcity, which determines the value of things. The FED may control the printing presses, may conveniently continue to focus on “core” inflation, but it cannot control the real economy; and the credit agencies that may eventually downgrade US debt.
Sunday, April 17, 2011
According to research published by the St-Louis Fed, non-financial after-tax profits are in full recovery mode since the Great Recession ended and this trend should continue for three different reasons:
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Friday, April 15, 2011
Leveraged ETFs allow investors to enjoy short-term juicy returns whether markets go up or down without the need to use margin accounts to sell the underlying security short. For example, investors who would like to position themselves to profit from a sudden market decline in the S&P 500 index can use two very different strategies:
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Monday, April 11, 2011
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Sunday, April 10, 2011
Bulls point that Ofirmev is a superior drug compared to post-surgical pain relievers opioid narcotics and NSAIDs currently used by hospitals, since acetaminophen has fewer side effects. In addition, management estimates that U.S. sales of Ofirmev could rapidly reach $600 million or higher in a few years, based on Perfalgan 22% market share of the intravenous analgesic market in Europe. If the market penetration of Ofirmev in the U.S. is higher, potential sales could reach $1 billion.
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Saturday, April 9, 2011
by Panos Mourdoukoutas - 4/9/11
After steering away from the Japanese stock market for almost twenty years, foreign investors are buying Japanese stocks to take advantage of the country’s reconstruction boom that is expected to follow the March 11th earthquake.
As I discussed in a posting on BubbleBustInvesting.com, investors shouldn’t bet on a robust Japanese recovery. As it was the case in the aftermath of the Kobe earthquake, this disaster isn’t going to change economic fundamentals. Monetary authorities can do very little to stimulate aggregate demand because they are in a dire situation. Thanks to several rounds of quantitative easing both short-term and long-term rates have hovered near zero levels for a prolonged period of time. This means that investors who buy into Japanese stocks now shouldn’t expect a boost from lower rates, and a boost from fiscal policy should be minimal, as money is expected to shift from building bridges to nowhere to repairing bridges to somewhere.
There is one company, however, that may be benefited even from a minimal boost in infrastructure spending, Kubota Corporation. The company is a manufacturer of a broad array of construction equipment, agricultural, machinery, waste and environmental gear, including iron and plastic pipes and filters, water treatment systems, drainage systems, water supply systems, etc. The company is further expected to benefit from a weakening yen that makes its products more competitive in world markets. Trading at around $46, Kubota’s stock has almost tripled since 2002, while the Nikkei lost almost half of its value. And although its fundamental lag behind those of its US counterparts, reconstruction spending and a weaker yen can reverse fortunes.
Company Recent Forward Quarterly Operating
Price PE Profit Growth Margin
KUB $46 15.08 58% 9.28%
CAT 110 13.14 317 9.38
DE 97 13.12 111.20 13.13
Disclosure: Long on KUB
Thursday, April 7, 2011
Peter Lynch's track record as a stock picker and fund manager is nothing short of spectacular. During his tenure at Fidelity Investments between 1977 and 1990, his Magellan Fund beat the S&P 500 in all but two years. The fund returned an annual average of 29% which compounded over thirteen years and led to a 28-fold increase in value. A mere $35,714 invested in the fund when it was launched was worth $1 million thirteen years later.
After retiring from managing the fund, Lynch became an acclaimed author when he laid down his investment philosophy in the New-York Times best-seller "One up on Wall Street." Perhaps his most well-known principle is that retail investors have an edge over professional fund managers because they get first-hand information on new products and services that Wall Street firms wait months for analysts to come up with.
Read the full article here.
Wednesday, April 6, 2011
Abbott Labs (ABT) opened with a pop on April 4th, 2011, following a positive review by Barron's senior editor Michael Santoli. The bullish call for Abbott is based upon thorough analysis of the company's fundamentals and can be summarized with a simple message: The stock is "unloved and undervalued."
In our opinion, the case to own ABT is even stronger. Three main factors affect a stock's market price: Fundamentals, technicals, and sentiment. All three factors are improving for Abbott, providing a tail wind to the stock for the rest of the year. Let's review each factor separately.
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Friday, April 1, 2011
With the price of oil soaring and the Fukushima nuclear accident dominating the news, investors have been flocking into alternative stocks, giving them a big pop. First Solar (FSLR) is up close to 40 percent since last year, and 12 percent since the Fukushima accident; LDK Solar (LDK) has almost doubled since last July. But there is a better way to play the rising oil prices and the nuclear energy fear: The smart grid.
A smart grid is an electricity network that applies digital technology to monitor and regulate the demand for, and the supply of, electricity. Network infrastructure products from Echelon Corporation (ELON), for instance, connect everyday appliances, such as air conditioners, with thermostats and electric meters, allowing both utility companies and customers to monitor and adjust energy demand from remote locations. Smart meters from Itron (ITRI) and Echelon allow utility companies to distribute efficiently and effectively electricity produced by alternative energy companies.
Read the full article here.