China Isn’t Doing So Bad After All…

Wednesday, 18th March, 2015

  • Why the Fed won’t raise rates
  • Income investing should be easy, soon it will be
  • If you’re a saver, you’re a money launderer
  • Watch the property clock

It’s another tough day for the resources sector.

Taking a big beating is Fortescue Metals [ASX:FMG]. As I write, it’s down 8% after scrapping a $2.5 billion bond sale.

Macquarie has cut its price target on the stock to just $2.10 per share. It’s currently trading at $1.81.

I’ll freely admit that Fortescue is a mining stock that I liked to profit from China’s ravenous demand for raw materials.

And despite the bigger-than-I’d-care-to-admit fall in the price, I still like the stock.

I even encouraged emerging markets analyst Ken Wangdong to include it in his New Frontier Investor service last year. He’s probably throwing curses at me right now as the stock continues to trend lower.

Fortunately, Ken’s Chinese stock picks are doing much better. His best performer is Chinese carmaker Great Wall Motor Co Ltd [HKG:2333]. It’s up 55.7% in Hong Kong dollar terms.

Adjusted for the weaker Aussie dollar over the past eight months, it’s up 93%. That’s a pretty darn good return by anyone’s standards.

Of course, it helps that China’s CSI 300 index is up 75% since last July. Compare that to the relatively lame 5.1% gain for the Aussie S&P/ASX 200 index.

This helps to highlight an important thing. The mainstream likes to talk a lot about how Australia relies a lot on the Chinese economy.

When Aussie resource stock prices fall, invariably the mainstream says it’s because of slower demand growth from China…or because commodity prices are lower…which is due to lower Chinese GDP forecasts.

It’s easy for investors to come away from this thinking that China is a complete mess…that the economy is about to collapse, that production is about to stop, and that the demand for resources is at an end.

And yet, China’s CSI 300 index is up 75% in eight months, the highest level since 2009, and stocks like Great Wall are up 93% in currency-adjusted terms over the same timeframe.

As The Age reports today:

Chinese stocks rose, with the benchmark index climbing to its highest level since August 2009, after Premier Li Keqiang pledged to take action if economic growth slows too much.

But this isn’t just about Chinese government stimulus.

This is about individual companies making the most out of a huge market that’s set to become the world’s biggest economy in as little as 10 years.

This is why I launched New Frontier Investor last year. It’s to help Aussie investors make the most out of the burgeoning growth in emerging markets, even as the Aussie resource sector takes a pounding.

And it’s not just China. Ken has also got his teeth stuck into India and Indonesia. The US-listed Indian bank that he recommended in October last year is up 28.4% in US dollar terms and 47.4% higher in Aussie dollar terms.

The difference is due to the falling Aussie dollar. Of course, if the Aussie dollar bounces higher, that would have a negative impact on the currency-adjusted returns.

But if the Aussie falls further (as most experts seem to believe), then that will provide a nice boost to the returns.

Ken’s working on his March issue of New Frontier Investor now. The last I saw, there could be up to three stock recommendations. At first glance, two of them seemed to be an odd inclusion for an emerging markets investment advisory.

But when I read Ken’s rationale, it all made perfect sense. Ken’s doing a great job keeping tabs on the world’s emerging markets. You can check out his service here.

Why the Fed won’t raise rates

The Aussie market is a great big splodge of red today.

AMP Ltd [ASX:AMP] is down 1.3%. Tactical Wealth stock pick Myer Holdings [ASX:MYR] is down 1.6%. Newcrest Mining [ASX:NCM] is down 1.3%.

Who knows why? No doubt the meeting of the Federal Open Market Committee (FOMC, the body that sets interest rates for the US Federal Reserve) started its March meeting last night.

Tomorrow afternoon it will announce its interest rate decision.

The markets are still convinced that the Fed is moving into a position to raise interest rates.

Some folks think the first rate rise could come as soon as its April meeting.

Quite frankly, I still don’t buy it. The Fed has already done a good job of knocking the market out of its bull market rally. The S&P 500 index has gone mostly sideways since late December.

That’s what the Fed wants. Remember, it doesn’t want to cause a market crash, but it doesn’t want to cause a rapid stock market bubble either.

It just wants to engineer slow and steady asset price growth. It can do that without moving interest rates. It can just talk about raising them and adjusting the language in the FOMC press releases to make it seem as though an interest rate rise is near.

But to actually raise interest rates in this market environment, when the US government has a US$16 trillion-plus debt, is another story.

Raising interest rates in this market could turn out to be a lunatic move. The market still hasn’t fully priced it in. If the market believed 100% that it’s about to happen, stocks would be much lower.

So the current, relatively high prices still suggest to me that the Fed hasn’t quite convinced the markets that they’ll go ahead with it.

Because if the Fed raises interest rates even by 0.25%, the potential knock-on effect could be extraordinary. The long awaited bond market crash could be swift as bond investors get out quickly, fearing another rate rise.

Stocks would collapse as investors would figure further rate rises and higher yields from lower stock prices…or even that some firms could go bust if financing costs soar.

As always, I could be wrong on this. If the Fed goes ahead and raises interest rates, then I’ll admit to being wrong.

But I just don’t see it.

Income investing should be easy, soon it will be

Next week we’ll launch a brand new entry-level income investing service.

The absence of an income service has been a gaping hole in the Port Phillip Publishing advisory armoury.

The man in charge of this service is Matt Hibbard. You’ll hear more from him next week. He comes to us with nearly 30 years of experience in the markets.

He’s a great addition to the team, and will help investors combat the unnecessarily tricky world of income investing.

It’s a shame, because investing for income should be easy. You should be able to buy into a stock that’s paying a good dividend and just leave it to compound returns for years to come.

The trickiest part is finding the right companies at the right time. They are out there; it’s just a case of knowing when it’s safe to buy them. Matt will aim to help income-needy investors through that decision making process.

Stay tuned for more details next week here in Port Phillip Insider, as well as in the free daily eletters.

(Of course, if you’re an Alliance member, you’ll have this new service automatically added to your membership. Look out for a special note next week with details.)

If you’re a saver, you’re a money launderer

It’s amazing how many people think I’m a lunatic for warning about the government’s plans to confiscate superannuation savings.

What’s even more amazing is how many people just don’t believe it will happen.

This email received today is a classic example:

‘[Kris] really needs to do a writing course. If I wrote as badly as that in my job…I would get the sack. He could cut it by 70-80% (which would be a boon for busy people) and still present his arguments. More people might read it (listening is even more frustrating).

Having ploughed through the article, he actually provides very little concrete evidence that the Government is planning to "seize" retirement funds. In any event, changes that might affect super savings are unlikely to be retrospective and reducing the tax concessions given to higher income earners (to make the system fairer) would not affect most of us.  Perhaps he is scaremongering so people will fork out for Tactical Wealth.

— Trevor

On the subject of taking a writing course, I can tell you that after being in this game for 10 years, the worst people to hire are those who have taken a ‘writing course’, or worse still, have a degree in journalism.

They come into the role after the university system has filled their heads with so much rubbish it’s nigh on impossible to beat it out of them. (And I’ve tried. You should see the dents in my cricket bat. No kidding.)

But Trevor’s dismissive attitude to the government’s plans is exactly why the government is likely to get away with it. They don’t have to make anything retrospective. There is $2 trillion locked up in super.

The government just has to say, ‘From today, that money is ours.’ And that’s it.

And as for scaremongering, you don’t have to spend more than two minutes searching for the word ‘superannuation’ on the internet, to find another piece of propaganda that plays right into the government’s hands.

Take this story that cropped up on the website last week:

“High-income earners get a tax break, while low-income earners pay more tax on their super than their income. It’s ridiculous,” Dr Denniss said.

He said the worst part of the scheme was that any income from superannuation was entirely tax-free if you were over 65.

“If people understood this there would be riots,” Dr Denniss said. “It’s legal money-laundering.

Mr Denniss is the executive director of the Australia Institute. calls it a ‘progressive think tank’. For ‘progressive’, read ‘socialist redistribution of income’.

Or to put it another way, and to paraphrase Julius Caesar, ‘Australians, give me your income.’

Your super savings are under attack. There is no other way to say it. And I’m prepared to go blue in the face saying it.

I don’t care if my going on about it annoys you or bores you. If it does, stop reading, close this email and come back tomorrow…but you’ll see the same message then too.

The way I figure it, no one else is willing to snap Aussies out of the hypnotic state they’re in about the attack on their super. So it’s up to me to do it.

Face it. This is happening. Lobby groups have locked in on this issue and they’re encouraging the government to do what the government wants to do — confiscate your private savings.

They won’t rest until they’ve done it.

If you haven’t checked out the full expose on the government’s plans to do this, do so now. This isn’t some made-up conspiracy rubbish. This is a real threat.

Take action now before it’s too late. The Budget is just 49 days from now. That will be the date when the government reveals its first confiscatory policies.

Now for a special guest essay from Cycles, Trends & Forecasts assistant editor and Daily Reckoning Podcast host, Callum Newman…


Watch the Property Clock to See How the Economy Will Move — and Why
By Callum Newman, Assistant Editor, Cycles, Trends & Forecasts

Our central theme over at Cycles, Trends and Forecasts is that we can predict the way the economy will move by studying the US real estate cycle. Historically these have run for an average 18 years, never shorter than 17 years and never longer than 21. Australia follows the lead of the US.

At the end of a real estate cycle there is always a major collapse. The last one was 2008. We don’t need to go into detail about that now. You know the story.

But almost everyone refers to it as a financial crisis, which is a mistake really. It was a land crisis first. The indisputable fact is that the crisis began in the US real estate market. That’s important, and it’s one of the things we teach over at CTF.

The point is that the financial crisis was actually a result of the collapsing property market. That’s because real estate formed the collateral for the trillions in outstanding loans. When the value of the properties fell below the level of credit lent, the banks had a serious problem. One that, if left unchecked, would have left them bankrupt.

A country with a bankrupt banking system goes into a depression. That’s bad politics — voters don’t like depressions. That’s why politicians all over the world sold out to the bankers. They did everything they could, from inflating the money supply and taking the bad debts onto the public balance sheet to make the problem go away.

This is, I might add, a pattern repeated throughout history. ‘The banks were saved, but the people ruined,’ is a quote from the 19th century.

The debate around government debts and deficits that has since overwhelmed the issue came about because central banks bailed out the banks from their poor property loans.

But the focus on sovereign debts actually obscures the real issue, which is always the property market. As a result, people generally worry and watch the wrong thing, or at least at the wrong time. It’s a mistake I made in the past myself.

That was then. Today we can look to the US property market to gauge the health of the US economy. There’s been some interesting news on that front, which is why I wanted to touch base with PPI readers today.

So if you’re worried about another collapse in the US, we don’t think you should be.

Take the Wall Street Journala few weeks ago . It reports that home loan delinquencies in the United States are at their lowest level since 2007.

In fact, the highest delinquencies are holdovers from the subprime years before 2007. Mortgages written since are healthy. Perhaps this quote sums it up best:

Foreclosures and delinquencies have plummeted in the past few years due to rising home values and employment growth. The high performance also reflects policies by lenders to make loans primarily to the most creditworthy borrowers, said MBA chief economist Michael Fratantoni.’

The level of subprime mortgages in the United States is actually tiny compared to the irrational levels of the boom years. This also bucks the trend for rising subprime loans across America for things like auto loans.

You can see that represented here:

Or, as the WSJ puts it in writing, ‘Mortgage lenders remain focused on borrowers with solid credit, according to industry data.’

You can see from the stats that the banks appear to be ultra-cautious with the loans they’ve written over the last few years (although this will change as the cycle turns).

This is showing up in the US with a higher proportion of people renting. One reason for that trend is that it’s hard to get a loan, and you need a big deposit.

The WSJ reported back in early February:

A resulting demand for apartments is rising so fast that it is starting to overwhelm supply in many cities, which is pushing up housing costs nationwide. “As the number of renters grow, if the supply of rental housing does not keep up—as it has not in most of these cities—then vacancy rates will fall, rents will rise, and more renters will struggle with the costs of housing,” said Ingrid Gould Ellen, the Furman Center’s faculty director.

Land values are rising again in the US. This is the cycle turning exactly as it should. We actually have a property clock that shows this process quite simply, and we’ve even dated it for you.

Rents rise, (at about 2 and 3 on our property clock), which leads to higher prices for established buildings. That in turn means it’s more profitable to build, and then you get a rapid expansion in new construction.

This process is not new. Homer Hoyt documented this process for Chicago from 1825 to 1930 in his 1933 thesis, 100 Years of Land Values in Chicago.

I’d like to show you a chart from the ‘new highs’ over in the United States.

This is the iShares U.S. Home Construction ETF (ISB)…

US Home Construction ETF at 52 week highs

Source: BigCharts

This index tracks companies in the home construction sector. The way I read the chart is that the market is pricing in growing earnings for these companies. That’s why it’s moving up. 

So we have positive signs in the real estate sector.

The other sector we watch closely at CTF is banking.

The Federal Reserve has nursed the big US banks back into profitability. The banks have been able to borrow from the Fed at 0.25% interest and then turn around and buy long term US Treasuries paying somewhere in the region of 2–3%. The spread they make on the difference rebuilds their capital base.

Now the Fed is beginning to indicate it will raise short term rates. This process is perfectly in accord with what we expect to happen.

You may be worried about the effects of rising rates on shares etc, and I understand that. But the one you really need to pay attention to is the effect it will have on the banks. As the Fed raises short term rates, the spread the banks earn on borrowing from the Fed and buying government bonds will narrow.

That decreases their profitability. Bankers don’t get their bonuses from shrinking profits.

The consequence is predictable: they’ll go looking for profitable ways to extend credit. That’s where all those renters I just told you about come into it. Then we’ll be well into the property clock.

I hope it’s not too facetious to say the economy is moving like…well, clockwork!

You can read the full articles I referenced above on the WSJ website. A lot of news is junk, but it’s easier to pick out what’s important once you have the right framework.

This is the power of understanding the 18.6 year real estate cycle. If you’d like to know more about the work we do, and how it helps time your asset allocation and investments, start here.

Callum Newman
Assistant Editor, Cycles, Trends & Forecasts