Thursday, July 25, 2013

This bull market has still a lot of steam

You may have the impression that the world stock markets would do a lot better if only China’s economy resumed its leadership. But in my opinion, nothing is further from the truth. First of all let’s look at those incredible GDP numbers that China posts at regular time intervals. Any western economy would kill for such growth, but if the Chinese economy really grows at 7 or 7.5% per year then why is China’s demand for commodities so far down the drain? Why are we even in a commodity bear market? If their GDP grows so much then their demand for natural resources should still grow at an impressive rate especially when combined with the economic growth of other emerging markets.

Then we hear that this month’s PMI (Purchasing Manager Index) in China fell below 50% suggesting a shrinking manufacturing sector. How do you do that while the economy is supposedly growing at a torrid 7.5% or so? There are also the Chinese banking and/or shadow banking crises. So, the Chinese ‘Wunder’ may not be so wonderful after all!
Really, ask yourself, why is Chinese output dropping? Why is, as its GDP numbers suggest, China’s economy drastically slowing? The answer, my friend, is not blowing in the wind! The answer lies in falling exports – or better lower imports from China by the Developed World! You see, in spite of all the Chinese hubris about the U.S. dollar not being a reserve currency anymore, China desperately needs those U.S. Dollars or better it needs the U.S. and European consumer to buy its products. China will apply every trick in the book to sell their products as cheap as they can using not only low labour costs but also all kinds of hidden subsidies to export to the West while creating all kinds of barriers for the Chinese people to buy from the West. Because if we, the West, don’t buy the Chinese ‘Wunder’ is over! If we don’t put massive investment dollars into China to build ever more factories, the Chinese public has no longer the money to speculate on their overvalued real estate markets.
So, Chinese growth of GDP is not a leading indicator of how the world and the world stock markets are going to do; rather it is a lagging indicator. First the Western economies of Europe and the U.S. will have to turn around and then the Chinese will follow. Not only the Chinese economy but most of the other emerging economies as well depend on the return of the Western Consumer. Even if these emerging economies will start to pick up steam again, it is far from certain that the Chinese stocks will benefit as well. In the past during times of high economic growth, Western investors in Chinese and other emerging markets only made moderate returns in highly volatile stock markets – so don’t count on highly profitable Chinese stock market results showing up in your portfolio anytime soon.
China being dependant on the Western world rather than the other way around is not such an amazing fact. Combining the U.S. and European economies, we’re talking about 34 trillion dollar of annual GDP compared to China’s 7 to 8 trillion dollars depending on whose statistics you believe.
European stock markets have been going up over the last year or so, recovering slowly from the 2008 financial crisis and the 2011-2012 European debt crisis. The U.S. has done better and its stock markets have been recovering from the lows of 2009 to new all-time highs. The recoveries in both super economies have been slow and somewhat steady. Now finally, we see more small investors – “Mom & Pop investors” - returning to the stock markets; they are slowly overcoming their fear of stock market volatility.

Stock markets are often leading indicators for improving economic conditions. Thus I foresee continued economic improvement for at least another six months. Combined with the QE (Quantitative Easing) and ECB Bond-Buy-Back safety-nets nearly guaranteeing at least some economic growth, I foresee that European and U.S. economies will not encounter a serious recession for at least another 2 years.  Since stock markets are still cheap on a Price/Earnings basis – especially considering today’s continuing low interest rate environment, stock markets should stay in bull market territory at least until 2015 if not longer. The bull market will last until investors turn irrationally bullish once again, the precursor of Mr. Market’s inevitable revenge in the form of the sudden on-set of a bear market.
Will it be more difficult to find stock market bargains from now on? You bet and I recommend taking from time to time some profits off the table; thus building up cash reserves for the next big crash. Don’t be afraid to let your profits run though; but also consider the use of ‘stop losses’ to ensure that you don’t give back all those hard earned profits in a sudden market crash.
For now, this is my most likely scenario: the U.S. in particular will benefit from the energy revolution resulting in cheap to affordable energy prices that will form the basis for a new manufacturing and high-tech boom in North America. A recovery in Europe will go hand in hand with that in the U.S. The European recovery will be less vigorous because of resistance to adapting the new drilling and production technologies that led to the U.S. Energy Revolution. Europe is much denser populated than North America thus the chance of experiencing a massive drilling and fracking operation (if permitted) under your house would be more likely in Europe than here in North America - hence the opposition. However, If you don’t believe that Europe has a magnificent competitive manufacturing sector capable of recovering significantly then count the number of BMWs and Mercedes on Alberta’s roads!  
With the improving European and U.S. economies, demand for resources will go up, in particular natural gas and to a lesser degree oil (whose prices are already approaching the economic limit) and you’ll see Canadian stocks slowly exiting the current commodity bear market. With increased Western consumer confidence, Chinese exports and thus its economy will improve in turn. Maybe levels of 10%+ GDP growth will be increasingly more difficult to achieve considering the current large size of China’s economy. However 8 to 9% GDP growth is definitely in the cards. That in turn will put Canadian and Australian commodity dominated stock markets back on fire. A booming Canadian stock market will also be the signal that we’re rapidly approaching the next economic cliff and stock market crash. Something that may not happen until 2016. If this scenario plays out, you may look back in 2016 and realize that we have been experiencing history’s longest lasting bull market!
This is not to say that between now and 2016 there won’t be scary moments and nasty corrections. Stock markets and economies don’t tend to go up in a straight line; more likely they will zigzag. So, focus on only investing in good value and sell your poor businesses. Avoid speculation and remember that over the long run, moderate dividend payers that consistently grow their dividends are often the best market performers – no matter what the interest-rate chickens may hysterically shout in the newspapers.

Over the near future, I suggest to invest in U.S. broad market indexes and in European markets, in particular those of Northern Europe (Germany, England, and Holland). Investing in Southern Europe is probably more risky but also potentially more profitable. Don’t forget to invest a portion of your investment funds here at home: banks, insurance, telecom are most promising. Later in the cycle ad more resource companies such as fertilizer and oil/gas producers – possibly even some miners (but that is getting pretty risky in my books).
Over the coming years interest rates are likely to return to more normal levels; we probably will even see inflation returning. It may be worthwhile in the later years of this extended business cycle to again buy some fixed income investments but that is still a long time out. For now, if you do invest in fixed income don’t lock in for more than a year or two and be prepared to share your meager profits with the tax-man.

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