Our Prayer: God Bless China

Only one word is enough to describe what happened to the global stock market: Boring!

Dow Jones went up 38 points and closed at 9,544 with even lower volume than the previous week. Most traders have gone for vacation to enjoy the summer holiday and I don’t expect any significant move from the stock market until they return some time in September. On the other hand, the Asian markets are losing ground. Shanghai lost 100 points and closed at 2,860, trying not to breach below the key support at 2,800. Hang Seng Index also lost 100 points and closed at 20,098, also trying to stay above the key support level of 20,000. Japan’s Nikkei was the only bright spot --- it went up 295 points and closed at 10,534 because the nation of a population of 100 million was expected to have a new ruling party to take over the government in the upcoming election. Although I’m not a political analyst but the vegetative state of Japan’s economy cannot be cured by any political parties. I don’t expect the Nikkei is going to turn around any time soon.

A lot of economists are doubtful about the current economic success of Communist China. Despite the declining exports, China is expected to maintain GDP growth of 8% this year. When the officials from the Chinese Finance Department went to visit to Washington last month, they were greeted with unprecedented respect by all the high profile politicians, from the Secretary of State Hillary Clinton to the Secretary of Treasury Tim Geither to President Obama. They all praised China’s economic success and used a lot of Chinese proverbs in their speeches, asking for more “cooperation” between two countries. Why did the Americans suddenly kowtow to China? It’s because China is holding $200 billion worth of U.S. Treasury bond and the largest debtor of the United States. Better pay some respect to the person whom you owe him the most money.

Will China be able to save the world? I am not sure. However, I think China has a chance to save herself. A lot of experts think that China cannot survive since the country depends on exports. Exports have declined by 25% in China because of the collapse of economy in the Western countries, such as the United States and the developed countries in Europe.

However, we have to look at what they export --- China produces necessities like shirts, pants, clocks, watches, fridges, toys and glasses, everything you see, you touch and you wear every day. On the other hand, what do the Western countries export? Computer software, train compartments, construction equipments and aircrafts.

I don’t care how poor an average Chinese is, but I do expect he should be able afford to buy a pair of socks every year. But on other hand, who would buy a bulldozer and put it in the backyard next year? What China exports can be, or at least have a chance, to be purchased by their huge population because they are necessity goods. But the goods sold by the Western countries are capital goods, or consumer discretionary goods that nobody would frequently buy. Eventually, it is the developing China who would buy what the Western countries produce. That’s why there are so many Western leaders try to make friends with China today. In other words, if China collapses, the Western countries will suffer even more.

Will China survive the current global economic tsunami? I don’t know. But if China cannot make it, neither can the rest of the countries in the world survive.

The Presidents of the United States often end their speeches with the words “God bless America.” To survive the current economic turmoil, we’d better end our prayer with the words “God bless China.”

Wait for The Hunt for the Red October

While the Asian market was on the verge of breakdown, the Dow Jones Industrial Average (DJIA) continued to hold up and made a new year-to-date high last Friday as if recession never occurred. The Dow Jones went up 185 points and closed at 9,505 last week, reversing the 200 point drop earlier on Monday. On the other hand, the Shanghai Stock Exchange Composite (SSEC) was in trouble and closed at 2960, struggling to get back above the 3,000 level.

Does anyone remember the term “decoupling”? As we all know, the analysts always love to invent some uncreative new phrases that have same old meanings. Few years ago, some analysts projected that the Asian stock markets, especially the Shanghai Stock Exchange Composite in China and the Hang Seng Index in Hong Kong, are going to not only outperform but also no longer under the influence of the American stock market. In other words, the Asian markets would be immune from the decline of the American indices. This phenomenon is known as “decoupling” since the stock market movements in the East and West are no longer correlated. But after March 2008, nobody talks about “decoupling” anymore when all the stock markets in the world all tanked in sync.

But the analysts always feel obliged to invent new terms. This time they have invented a term called “China Syndrome.” As mentioned in most recent financial reports both in the press and on the web, this term refers to the negative effect of the Chinese market on the global markets. If China tanks, the rest of the stock markets in the world are also going to tank.

This “China Syndrome” phenomenon is indeed valid --- for one day only. The DJIA fell more than 200 points last Monday and most analysts blamed on the precipitous fall of the SSEC from China, which fell from 3,500 to as low as 2,760 in the last three weeks. While most stock investors were about to point their fingers at the Chinese, the DJIA made a U-turn and went up again for the rest of the week. All of a sudden, the “China Syndrome” disappeared.

And let me make a following prediction: The word “Greens Shoots” will disappear as early as March 2010. Most professionals, such as the economists who often make wrong predictions and the fund managers who often make wrong decisions alike, have claimed that the economy is getting better. They used different jargons and numbers to explain their reasons but basically they all have the same conclusion --- things just can’t get any worse.

I am not a professional economist nor am I a fund manager (although I do wish to become the latter one if my destiny permits), I do believe in something called history. If you search online and look at the history of Dow Jones, you’ll that a bull market usually lasts for about 5 to 7 years while a bear market about 3 to 5 years on average. But if we look at Japan, their Nikkei Index started falling in 1990 and still cannot claw back to the previous high 19 years ago as of today. Strictly speaking, Japan has suffered a bear market that has lasted for 19 years!

If we count October 2007 as the beginning of a bear market when Dow Jones fell from 14,198 and claim that the calamity was over when the index hit 6,647 in March 2009, does it mean that this bear market lasted only for 15 months? Do you believe, really believe, the financial crisis that started 10 years ago, resulting in the fall of Merrill Lynch, Bear Sterns and Lehman Brothers and millions of people losing their homes and jobs, could all be resolved in only 15 months? Do you think the crisis is now over?

As I said before in my column, the Wall Street is still propping up the market and tries hard to lure more capital in the stock market, creating an illusion that the economy is getting better. I don’t know how long the Wall Street will sustain the rally but I am very uncomfortable with the low volumes and the relatively high put/call ratios during the rally. Think about it: Why do people still buy put options if they are going to hold their long positions for a long time?

I think, totally out of my intuition, the current rally is mainly participated by sophisticated investors, such as the traders of the investment banks or the hedge fund managers, who still want to lure individual investors to the stock markets.

Why do they prop up the market now? Why don’t they play the short side? Let’s say they are going to short the Dow Jones Industrial Average now. What is their maximum profit? The current 9,506 point worth of future contracts, right? It is because the stock index cannot go below zero. But if they can prop all the way up to 10,000 or higher, they can win by shorting 10,000 point worth of future contracts and bank home with more money. And who is going to pay for it? The individual investors who are going to pay up for the stocks they sell.

Based on the current extreme overbought condition, I do expect a serious duel between the bulls and the bears some time in September or October. Perhaps I may be wrong. Maybe it is indeed the beginning of bull market. However, I will stay away from the storm for now. If you believe the stock market will go down and turn red again, I think September or October is ripe to play for the short side. Let’s wait for the Red September or October.

It’s “L,” not “V”!

While the pundits have kept telling us that the American economy is going to rebound strongly in the second half of this year, the retail sales and the initial unemployment claim numbers announced last week both nullified their claims. According to the statistics released by the U.S. government, the initial unemployment number jumped to 558,000, which was more than 543,000 as expected by most economists. The retail sales number was even more disappointing --- it contracted to negative 0.1% instead of 0.2% growth as most economists expected. What are these two numbers implying? It means that many Americans are losing their jobs and are afraid of being a layoff victim; therefore, they are holding off their spending.

Although it is obvious that the economy is not going to improve in foreseeable future, a lot of experts, or so-called “experts,” are projecting a possibility of a “V” shaped recovery is coming to town. I did not read every single article or commentary by those “experts,” but their reasons are mainly based on the “stability” of the credit markets and the American big banks. However, the meaning of “stability” is NOT equivalent to “recovery,” both in economical and literal sense.

Thanks to the U.S. government that used U.S. taxpayers’ money to rescue the investment banks because they are “too big to fail,” the American financial system is not getting any worse, for now. However, the fact that the banks are doing okay does not mean the economy is going to be okay. Think about it: How can an economy recover when 500,000 more people have become unemployed every month?

Also consider the statements released by the Fed chairman Ben Bernake last week. In general, he said that the U.S. economy has “stabilized” and he intended to keep zero Fed rate policy because inflation does not seem to be a present danger. He is also planning to reduce the amount for purchasing U.S. long term bonds, implying that the Fed is withdrawing its role to save the U.S. economy.

I remember I watched an episode of a U.S. TV show few years ago, not sure if it is a comedy or a soap opera tragedy, about a car accident victim who becomes a comatose patient with his parents sobbing by his bed side. When the agonized father asks the doctor about the condition of his son, the doctor tells him with a medical answer, “Your son is now stabilized.” I think this is what Bernake really meant when he used the word “stabilized.”

Think about it again: Why didn’t Bernake use the word “recovered?” If an economy really recovers, what should happen is a mild inflation when the demand for goods increases. This is a simple but universal condition for an economic recovery. However, he said that inflation is not pending. It only means the U.S. consumers are not buying goods as reflected in the declining retail sales number. The banks are safe because the government rescued them. They are now loaded with money to speculate again (see my previous columns on this blog). But economy is about the people, not the few big financial corporations. A true recovery can never become realized if people are losing their jobs and cut their spending.

What I am afraid is that the direction of the North American and European economies in the West is going to the follow a "L-shaped” path instead of a “V-shaped” path. What I mean is that the economy first sharply plummets and then stays low and stagnant for a very long time.

We have to realize that the economic boom from the last ten years was due to over-leveraging thanks to the low interest rate environment established by Alan Greenspan. The creation of Fannie Mae, Freddie Mac, subprime mortgages, commercial back securities, credit default swaps and receivable derivatives directly and indirectly made most people “rich” by making them become a property owner to own a property that they cannot really afford. After the bubble burst in 2008, all those leveraging processes are now deleveraged --- houses are foreclosed, house owners have to pay their debt and many more people lose their jobs. And do you think the problems that have been created in the last ten years could be resolved in only one year?

I think the economy in the West is like a comatose patient in vegetative state: It is not dead yet because the government intervenes to save the financial sector but neither is it alive because the unemployment will likely remain high. Do not expect the patient will revive any time soon. It will be lucky already if the patient does not end up dead.

Bearing with the Unbearable Bear Market Rally

The summer has been unbearable for the bears --- the three main stock indices, Dow Jones Industrial Average, NASDAQ and S&P 500, continued their gravity-defying rally last week. Dow Jones Industrial Average (DJIA) closed at 9,370 and went up by 2.16%; NASDAQ and S&P 500 both achieved year-to-date highs and closed at 2,000 and 1,010 respectively. The stock markets on the other side of the globe, however, started to show some weaknesses. The Shanghai Stock Exchange Composite (SSEC), which has outperformed all stock markets in the world so far this year, lost 62 points and closed at 3,349. Hang Seng Index from Hong Kong also suffered a 197-point drop and closed at 20,275, trying to stay above the key 20,000 level. Although there is not enough empirical evidence to show a high correlation between the Asian and North American stock markets, the current deteriorating condition of the Chinese and Hong Kong indices do warrant some caution for the investors.

The good news, or the so-called “good” news, was the unemployment number announced last Friday. According to the U.S. government, the unemployment rate in July was 9.4%, far better than 9.7%, which was expected by most economists. The bulls celebrated this “good” news as long as they saw the number was lower than 9.7%, ignoring the details of the report. Abby Cohen, a senior investment strategist at Goldman Sach, even proclaimed that it is the beginning of a new bull market; she also predicted that the S&P will hit 1,050 to 1,100 in the second half of this year.

Perhaps I am a curious person with too much time and too much energy, I cannot see how this “better-than-expected” unemployment rate as something positive when I dug up the details of the unemployment report. First of all, let’s see the definition of the “unemployment rate.” According to the report released by the U.S. government, it is the percentage of job-seeking individuals who cannot find a job over the "total labor force." However, the unemployment rate does not count the number of people who give up looking for a job. Those people are called “discouraged workers,” who simply throw in a towel after sending out hundreds of resumes without getting called. And how many people were discouraged workers in July? 796,000, up 335,000 over the last 12 months!

Besides the “discouraged workers,” there are also people who are “marginally attached to the labor force.” Who are these people? According to the definition released by the States, they are the people who cannot find a job for about a year and have just stopped looking for a new job 4 weeks prior to the survey. In other words, they are the potential discouraged workers. How many of them? 2.3 million, up 709,000 more people compared to last year!

So, let me grab my calculator. The number of unemployed people up to July was 14.5 million, which is equivalent to 9.4%. However, if we count the people who are not going to work anymore and the folks who just threw in the towel 4 weeks ago, the “actual” unemployment rate was to 11.4%! I call it “actual” because they are, literally, not working at all. And how could it be good news?

But it doesn’t matter. The stock market is now at a party mode where good news is good news and bad news is good news. It is like the ultimate financial consequences of a marriage --- your wife’s money is her money, your money is her money. However, I do sincerely suggest you to sell your long positions as the Asian markets have now deteriorated, indicating the speculative craze has now become subdued. If you are aggressive, consider adding short positions for an impending correction that would come as early as some time next week.

Don’t Dance with Cinderella

The stock markets last week have made most technical analysts feel ashamed again. While the technical analysts have been yelling how “overbought” the markets are, the stock markets continued to party all the way to year-to-date highs. The Chinese stock market was the most spectacular --- SSEC, the Shanghai Stock Exchange Composite, has climbed from 1,815 to 3,412 in seven months, a whopping 88% gain so far this year. On the other hand, Dow Jones Industrial Average (DJIA) only ran from 9,035 at the beginning of the year to 9,171 last week, a meager 1.5% gain. No wonder why so many parents from the West have forced their kids to learn Chinese. Perhaps China is the future for business and the 21^st century is indeed the Chinese Century.

The so-called explanations for the rally last week, as reported by most analysts, are again the “better-than-expected” financial results from the companies, thanks to their aggressive layoffs and cost cutting plans. Another the so-called “bright” spot of the market was the latest GDP result. While most economists expected - 1 5% GDP growth during the second quarter, it came out only - 1.0%. BUT meanwhile, they revised the GDP figure of the first quarter of 2009 downward from -5.5% to - 6.4%!

Although I am not an economist nor am I a mathematician, please think a little hard about the numbers --- how could they be considered good news? It was thought that the GDP had a - 5.5% in the first quarter and also a -1.5% this quarter. In other words, it was thought that there was a -7.0% in the last two quarters combined. But the actual results were - 6.4% in the first quarter and - 1.0% in the second, a total of - 7.4%! It is actually 0.4% WORSE than most people expected (-7.0% vs. -7.4%)! How on earth could it be good news? Moreover, the current - 1.0% may be revised downward again when the government reports next time. Either the U.S. government has no credibility whatsoever or the statisticians do not even know how to use the calculators.

As I mentioned in my last column, why did the stock markets keep rallying for consecutively three weeks despite the low volumes? My theory is that the U.S. investment banks have been provided with a high level of liquidity by the U.S. government (e.g. almost zero Fed rate and TARP program) and are using the money to invest in equities to bid up the prices, and therefore creating an illusion that the bull market has returned.

Think about it: Who still has money after March 2009 when most individual investors already got their investments cleaned out? It is only the big banks and investment dealers who still have capital left. That is why the volumes have been so low – it’s only the big guys who are playing!

In other words, the stock market is now in the hands of speculative traders that could dump their shares when they think the time is right for them. That is why I do not suggest individual investors to venture the current stock market now because we never know when the big guys will dump the shares. If you start buying stocks at this moment, you are like Cinderella going to the party without wearing a watch. Yes, you may be having a good time at the party and the magic of your glass slippers may make the rally go a little higher. However, the party will eventually be over at midnight --- before you realize that the magic is gone and the time is up.

In fairy tales, there are miracles, dreams and hopes. In stock market, however, there are only bulls, bears and pigs --- and it is always the pigs who believe in fairy tales that got slaughtered.