This Time It's Different

Regular readers of MOS will know that we have turned bearish several months ago. The market may go up tomorrow and the day after but the probability of a huge crash simply increases. In fact, we have been issuing "warnings" about possibly how hyper-extended this market was. But, a complete correction never quite came. Yes, we were prescient in calling the February sell-off; but the massive bloodshed that would create enormous value on the Street never quite materialized.

So, is this time different? Absolutely. We are living in unprecedented times. Unprecedented to the extent that every conceivable asset class that we know of, from real estate to infrastructure to commodities to junk bonds, are trading at steep valuations. Look at the estimates in the list below. Simply put, there isn't any asset that is sufficiently cheap to entice loss averse guys like us.
Estimated cumulative performance of key asset classes (Mar 02 to Mar 07):
Equities -

• S&P 500: 36%
• Russell 2000: 68%
• Energing Market equities: 221%

Bonds -

• US government bonds: 28%
• US junk bonds: 64%
• Emerging markets debt: 87%

Many institutions still keep an eye on US numbers to serve as a barometer to the world economic growth. This is in line with the thoughts that "when Uncle Sam sneezes, the world/tiny Singapore catches a cold". But MOS thinks that this exercise is becoming increasingly meaningless. We should instead be looking to China. The rising superpower that is mopping up American debt. The "Joe Chink" that is working hard and lapping up assets of the "Stars and Stripes". It has kept the latter from imploding despite running a trillion dollar current account deficit. Indeed, one of the indicators investors buying into emerging countries watch is the current account deficit as a percentage of its GDP. 5% is usually the level institutional managers get nervous and when they would prepare to yank their monies out and sending its currency in a downward spiral. Is the US too big that it defys the laws of conventional macro-economics? Or will there be a time for payback?

Its true that Chinese companies are, likely to be at the behest of the government, making attempts to correct the deficit. PC maker, Lenovo, recently inked a deal to purchase operating systems from Microsoft. There will be more purchases to come. But we consider this to be just a signaling exercise which will not correct the root problem.

We are big fans of the Americans. A global policeman, friendly people, beautiful cities and of course, who can forget the American Dream. But unfortunately, trees do not grow to the sky. The Chinese have decided to set up a national agency to invest their assets into "solid"/hard assets. They will be cutting down on their purchases of American paper, to gradually stop funding the American debt. Isn't it almost like dishing out the cold turkey treatment?

Its almost like the leadership baton of this century will be passed from the Americans to the Chinese. Sure, the UK had its glory days, two centuries ago. The last one was America's time in the sun. This century, as it is increasingly suggesting, is going to be China's.

There is a huge construction boom, a housing boom, a stock market speculation fever. Folks on the Mainland are rushing to open security trading accounts. Admittedly the Chinese government has done a great job, in managing to keep affairs humming along. Selective curbs on infrastructure investment, small hikes to bank reserve requirements. Things have been kept on the slow boil. But there will surely be growing pains along the way. When? After the 2008 Beijing Summer Olympics did someone guess?

We do not know when and what will cause this bubble will pop. But the clock will strike twelve and turn much to mushy pumpkins, to many party goers' dismay. But if asked to venture a guess, we will put our money that this house of cards will start unraveling from China.