February 12th, 2011
in Op Ed
By Michael Pettis
Because of the lunar New Year festivities, when I wrote my weekly commentary little had happened in China besides the 25 bp interest rate hike on Tuesday, not counting, of course, the never-ending stream of fireworks and the several really great jaio zi dinners I have managed to snag from my students and their families. I have nonetheless been getting a lot of questions recently about what I expected for the stock market this year.
The first and most obvious question now is whether the latest interest rate hike will hurt the market. I am pretty sure it won’t, except for some of the most obviously liquidity-dependent stocks, like real estate developers. And even then, the increase in rates is too little too late given the surge in inflation. I suspect that when inflation starts to come down, as I think it will by the end of the first quarter or during the second quarter, it should hurt real estate developers more as it more rapidly forces up the real borrowing cost. Follow up:
Liquidity Will Drive Chinese Stocks Higher
In general I think ample liquidity is going to drive stocks higher until at least the end of the summer (assuming of course, perhaps unrealistically, that no more countries unexpectedly fall into default or revolution). But later this year I think a lot of people are going to be rethinking their positions, and investors should be prepared for a rocky end of the year. Why? Don’t forget that the new leadership will be announced in 2012, probably in October, but the actually decision will probably be made much before then, maybe in early 2012.
If that is the case, by the end of this year a lot of insiders are going to be wondering about the policy objectives of the new leaders and whether it is indeed true, as the rumors have it, that they are uncomfortable with the current investment-driven growth model. Any revision of the model will inevitably have big impacts on growth, profitability, and commodity prices.
But until then the market should be strong. Last May I argued that in an effort to keep growth rates high in 2010 and 2011 we were going to see rapid credit expansion in China which, coupled with increases in hot money inflows, would mean tons of liquidity in the Chinese markets. This, I argued, would be very good for the stock markets and for asset markets in general.
Although I was a little early in my stock market call (the market declined for another five or six weeks) other asset markets soared throughout the period. Real estate prices have been on an upward tear, while everything in China that might be considered collectible and capable of holding value – gold, jewelry, premium tea, premium liqueurs, stamps, calligraphy, art, antiques, jade, and so on – has surged in price, in almost every case to record highs.
And in November I experienced one of my favorite indicators of a liquidity-induced bubble: I was speaking at an investor event, and after my standard bearish presentation I was followed by an effervescent partner of a local foreign-owned financial-services company. After explaining graciously that professor Pettis was great on “theory”, he pointed out that he himself preferred to look at “reality” when making predictions (isn’t it always a worrying sign when they say that?).
And from checking out China’s reality (he called it “looking out the window,” throwing in a half-mistaken reference to Keynes) he was pretty sure that Chinese growth was healthy, sustainable, and solid. Talk of a bubble, he insisted, was wrong. And then he produced his trump card. Did we know, he asked the audience slowly and significantly, that Lamborghini was planning to double their sales offices in China this year? With an explosion in the sale of luxury cars how could anyone think there was a bubble?
And by the way its not just Lamborghini – BMW is expecting double-digit sales in China in 2011. With evidence like that how indeed could you think there is a bubble? Yikes!
Yes, Deputy Finance Minister
At any rate I expect China’s GDP growth to be very high this year, and to a lesser extent also expect the local stock markets to put in a good performance, at least until the late summer, although I don’t make a connection between the two, as I explained in an article last June in the Financial Times. I also don’t expect a collapse in the bubble so much as long period of grinding away the investment excesses, accompanied by much, much lower GDP growth numbers for a decade or longer.
But to leave China and turn to the country of my birth, on Tuesday Bloomberg had the following article:
Spain will never need to tap a European Union bailout fund and will succeed in cutting the euro-region’s third largest budget gap and shoring up its savings banks, Deputy Finance Minister Jose Manuel Campa said.
“We’re fully convinced that we’ll never need” an EU rescue, he said in an interview with Andrea Catherwood on Bloomberg Television’s “The Pulse.”
…“For the first time in three years, I’m starting to see the light at the end of the tunnel for our country,” Francisco Gonzalez, chairman of Banco Bilbao Vizcaya Argentaria SA, told a news conference in Madrid today.
I suppose it is a little invidious for me to mention that the first time the phrase “light at the end of the tunnel” was used in conjunction with the economy was by President Hoover in 1931. Its probably even more invidious if, in responding to Campa’s promise that Spain will never need to be bailed out, I quote one of my favorite British comedies. “The first rule of politics,” Sir Humphrey, the wily civil servant in Yes Minister, insists is: “never believe anything until it is officially denied.” Yikes again!
The Bloomberg article lists Spanish debt as being equal to 64% of GDP and quotes Campa as saying that Spain will “make good on its pledge to get its deficit down to 6 percent of gross domestic product this year.” Campa also says Spanish savings banks, or “cajas”, will fare well in a new round of stress tests meant to expose any weakness in capital levels.
Maybe, but my admittedly anecdotal evidence while I was in Spain suggests that there was so much incredibly foolish lending into real estate over the past decade or two that I would be very surprised if a correct accounting of contingent liabilities in case of any serious disruption did not cause those debt numbers to soar, even if the government succeeds in keeping the fiscal deficit down to “merely” 6% of GDP. I expect that this year we are going to start seeing serious political resistance to the steps needed to bring debt numbers to manageable levels.
I wrote about this three months ago when I argued that the process of assigning the costs would almost certainly cause a radicalization of European politics, and the longer it went on the more radicalized it will be. So check out this article in Monday’s Financial Times:
There has “never been a greater need for republican politics”, said Gerry Adams, president of Sinn Féin, as he set out his party’s distinctive policy pitch for Ireland’s general election later this month. The country’s centre-right Fine Gael and centre-left Labour parties – which polls suggest will likely form the next government – say they will seek to renegotiate parts of the €85bn bail out with the European Union and International Monetary Fund.
But Sinn Féin – once best known for its links to the Irish Republican Army – will go further, Mr Adams told reporters at the launch of his party’s campaign on Sunday. It promises to reverse the budget cuts, impose losses on the international bondholders who lent to Ireland’s crippled banks, and tear up the EU-IMF deal. As voters absorb the cuts announced in December’s austerity budget and look to the left, the party is well placed to capitalise on Ireland’s economic woes in the February 25 election.
Now of the many topics about which I know absolutely nothing, Irish politics may well be near the top of the list, so I will try not to read too much into this, but it is pretty clear to me that over the next few years we can expect a bull market for radical political parties and radicalized factions within the main political parties. I have lived in Spain long enough to suspect that the Spanish (and the Portuguese and Greeks, for that matter, not to mention other countries), are not likely to fall behind the Irish when it comes to political anger.
How will the politics evolve? To answer I can only turn to Lewis Carroll:
“That depends a good deal on where you want to get to,” said the Cat.
“I don’t much care where—” said Alice.
“Then it doesn’t matter which way you go,” said the Cat.
“–so long as I get somewhere,” Alice added as an explanation.
“Oh, you’re sure to do that,” said the Cat, “if you only walk long enough.”