Neither Here Nor There

It’s December 29, 2008, and the end of year is not far away. If you’re in finance, you’ll probably say, “Good riddance!” or “Thank goodness!” There are a lot of you out there, I know. So can we look forward to 2009? Will things be better?

More than likely, things will be better in 2009. Still, we can’t quite jump for joy. We can expect many of the problems that plagued us in 2008 to continue into the next year. And on the flip side, it’d be hard to imagine events that were as earth-shattering as those that came upon us in the last year.

Neither Here Nor There

For the sake of discipline, let’s be a little analytical about this. On the upside, we have a new administration taking office in the latter half of January. The change in leadership, and the fact that Obama will favor stimulus packages, will give us a bit of a lift. Still, whatever programs that Washington enacts will take time to take effect. And in the meantime, I don’t see a lot of reasons for buyers to say, “I have to be in the market.”

On the flip side, there’s still downward pressure. The biggest may be the fund redemptions that would occur in the latter half of January. Those that couldn’t get their money out in December will do so in January. In addition, the Madoff scandal will make many ask for their money back from fund managers. That will create selling pressure in the later half of the month.

There are also a lot of fundamental problems that are still in the process of being worked out. Layoffs may lead to further pressure on real estate prices, and that in turn will pressure real estate-related assets. These assets are still being held by banks, insurance companies, funds and so forth. So that downward pressure will continue.

Beyond housing, the same ripples will continue to flow through the credit card, the auto loan and the commercial real estate markets. Given that we are looking at a terrible December for retailers, there will be lots of store closings, and that will in turn pressure mall and strip mall owners. More defaults and bankruptcies to come, I’m sad to say.

At the end of the day, we have some factors pushing us upward, and we have lots of others pushing us downward. So on balance, we are not likely to make a sharp move in either direction. We’re more likely to wander around, not moving far from where we are now.

That’s not all bad news. Technicians would call this “basing”, building support for an upward move at a later date. During this period of “basing”, neither the bull nor the bear wins, they just trade back and forth. If you think about the psychology of it, it makes sense. The good news is that we’re unlikely to have another Lehman or Bear Stearns. The government has learned that it is necessary to act, and that it shouldn’t allow companies that are critical to the system to be wiped out. So while stocks can still decline, the catastrophic “collapse of the system” scenario is less likely. At the same time, we don’t have a huge reason to drive the market up because a lot of the problems aren’t over. As a result, we have a kind of apathy, where many just stay out of the market. The institutions just buy Treasuries, which is why yields are so low right now. The longer that period of apathy lasts, the more time we have to work out problems without severe downturns in the markets.

You can already see this pattern of behavior in the markets. Take a look at the following chart of the Dow. Last month, I mentioned that we were stuck within a trading range. We’re pretty much still in that range, now roughly between Dow 9,000 and 8,200. This would be the “base” that is being built:

One other indicator that I’ve been looking at lately is the VIX, which is an indicator of volatility. In more “normal” times, the VIX is in the low teens. A VIX of 30 is already considered very high in most environments. This last fall, the VIX was as high as 80. You can see that since the fall, the VIX has calmed down somewhat and it’s now at 43 or so. It’s better, but by no means where it would be in more stable times. So the simple message: things are better, but it’s not over.

What does all that mean if you’re a stock investor? You could buy now, but you’re likely to run into continued ups and downs for at least several months. If you have the stomach for it, and the patience, there are stocks – “ and yes, be selective – “ that you can buy now. Alternatively, you can wait for conditions to improve and then buy.

How do you know when conditions improve? Ideally, you’re looking for signs that things have stopped getting worse – “ that real estate prices have stopped going down, or that most of the “toxic” assets on the books of banks and investment houses have been written off. Admittedly, this is difficult to determine. As a secondary indicator, we can go back and look at the Dow and the VIX. When the Dow breaks out of its trading range, and when the upward resistance point turns into support, then we have an important change in market sentiment. Also, when the VIX declines to more stable levels. In my opinion, falling below 30 or so – “ and staying there – “ would mean breaking through a major technical indicator. So while these are not the “perfect” indicators, they do tell us that the market’s evaluation of our problems has changed.

One thing to keep in mind – “ if you choose to wait, doing nothing is a perfectly acceptable approach.

China – “ Decoupling Is Dead, Right?

Last August, in the midst of Olympic fever, I wrote an article entitled, “China – “ A Post-Olympic Letdown?” At the time, there were many proponents of the “decoupling” theory. That is, that China had developed its own independent growth engine, so even if the West went into recession, China would continue to press forward. I questioned that thesis, especially with all the major industrialized nations headed toward some kind of recession.

Today, all indications are that China has not decoupled; that in fact, China is still highly dependent on the West for exports. With economic crises in the West, factories across China are closing, people are out of jobs, and the possibility of social unrest is high. China’s teeming populace will suffer, along with the Western economies.

Last month, I spoke at an Asian venture and technology dinner, and I pronounced the “decoupling” theory dead. Despite many news reports and articles affirming this point of view, I still received many objections. They pointed to China’s growth, and to the expectation of continued growth. The Chinese government expects to grow 8% this year, compared to 11.9% in 2007. All this, while the West is facing negative growth.

Make no mistake, I agree that China will continue to grow while the West pulls back. Over the long term, I think China will be a solid investment; I’m not debating that at all. I do think, though, that the decrease in China’s growth will be greater than the “decouplers” expect, and China may very well not make its 8% target. And keep in mind, data from China is very iffy. Even if the government announces 8% growth in 2008, I’d be skeptical – “ reality could be a very different story.

Why does all this matter? Because as an investor, you may want to wait before jumping in and investing in China. After all, timing does matter.

Much of the decoupling argument relied on the belief that domestic consumption would be the engine of growth. As an investor, that’s what you really what to know – how much of China’s growth is based on domestic consumers buying, versus foreigners buying the country’s exports. Recent work suggests that much of China’s growth is driven by government spending and exports, not by a wealthy Chinese populace. In a recent New York Times article, published December 21, 2008 and entitled “The China Growth Fantasy”, Yasheng Huang, Professor of International Management at the MIT Sloan School of Management, notes that for the past 20 years, rural household incomes have grown at about half the rate of GDP. That means there’s been a great deal of spending, but the wealth of the rural household has grown at half the rate of the economy. So much of that wealth went elsewhere – “ to the Chinese government to pay for its various needs, and to the US, Europe and Japan.

Consider as an example what happens to real estate in China. Because the government owns all the land, people are usually amazed by the speed with which property can be developed. But when you look behind the curtain, you’ll find this all comes at a cost to the average citizen. In fact, it’s the local governments, developers and foreign businesses that are profiting from the land. China has no real estate tax and income taxes go to the central government. As a result, local governments have been filling their coffers by flipping real estate. They push out the local residents, usually paying them only a minimal amount, sell the land to developers and pocket the profit. The bulk of the wealth goes not to the average citizen, but to local governments, developers and perhaps even the condo owners and the businesses that use the land (for more detail, see Yasheng Huang’s article, as well as “Builder Soho China Stumbles in Beijing,” New York Times, December 24, 2008).
The Chinese government itself has admitted that the country needs to increase private spending. Last Friday, China’s central bank governor, Zhou Xiaochuan, said that consumption was “a weak chain in our country’s economic structure” (“Chinese Industrial Profits Shrink,” Wall Street Journal, December 28, 2008).

All that means private consumption will not save the Chinese economy, perhaps some day in the future, but not now. China will need to take care of itself and mend its economy, just as the West does.

Until the next time, sleep well.

Ming Lo is an actor, director and investor. He has an A.B. from Harvard College, Cum Laude, and an MBA and an MA Political Science from Stanford University. Prior to going into entertainment, Ming worked at Goldman, Sachs & Co. in New York and at McKinsey & Co. in Los Angeles.

All material presented herein is believed to be accurate but we cannot attest to its accuracy. The writings above represent the opinions of the author, and all readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed may change without prior notice. The author may or may not have investments in the stocks or sectors mentioned.