We are living life in a fast lane. A decade ago it would take a market correction one week to complete, today it will take one or two days. Sentiment had calm down a lot after the mini-crash in global stock markets on Monday, most of the Asian market recorded minor gains on Tuesday. One exception was China ’s A-share market with SHCOMP index down 0.27% to 2,767. HSI rose marginally by 19-point, or 0.09%, to 22,730 coupled with a turnover of only HK$51.9bn. The HSI also demonstrated a very narrow trading range of only 123-point throughout the day.
Although sentiment improved somehow, investors remained cautious and few were brave enough to seek bargain hunting. This explained the continuation of low trading volume. For the blue chip stocks, it was obvious that investors continued to worry about a slowdown in global economic recovery, companies with international exposure tended to suffer the most with Li & Fung (494.HK) down 2.6% and COSCO Pacific (1199.HK) fell by 2.48%.
One important factor was that the rise in the U.S. dollar value was forcing carrying trades to unwind causing the rapid fall on Monday. The Europe debt crisis was merely an excuse, in my opinion. I have faith in EU and IMF being capable to devise some short-term relief programs to stop any debt-strapped European nations from defaulting. Finding a long-term solution for the debt crisis will not be easy, some radical reforms would be necessary.
A country’s finance is no different from an individual’s finance. For example, Mr. X earns $200,000 per year but is $1 million in debt. These debts will mature gradually over the next 3 years but getting re-financing is not easy given the tighter liquidity. Also lenders’ attitude has changed in the fear that Mr. X may become unemployed or may go broke. Mr. X has no valuable asset for sales either.
Every time when Mr. X is about to declare bankruptcy, his rich relative steps in and offers some financial aids fulfilling the short-term liabilities, such that Mr. X stay afloat. This is exactly the situation in Europe today, and it does not take a world-class economist to deduce that such approach cannot last forever. But given that no one is willing to take the pain, especially politicians are trying everyway to please their voters, I expect the reform will only come when other possible options have exhausted. Namely, it may only happen a few years from now.
Now let us move back to our China ’s story. As I said yesterday, I expect China ’s CPI to peak in July, don’t count on my exact timing, I can only get it approximately right at best. By the way, the reported April CPI is at 5.3%, if you ask the local living in Beijing or Shanghai , they will tell you that it is more like 10%.
I see there are two forces driving the recent inflation: (i) external – the liquidity created by various central banks across the globe after the financial tsunami, (ii) internal – liquidity created by the Chinese authority itself.
The underlying problem is the fixed currency regime. In theory, when a country is earning a lot of money from exports, this will put upward pressure on its currency. This is a self-adjusting mechanism and exports should slow down when currency value becomes higher. But China always controls the RMB and the cheap currency just keeps on boosting exports. China ’s foreign currency reserves have ballooned from US$403bn in 2003 to US$2,547bn at end of 2010.
Because the RMB is not freely convertible and the exchange rate is fixed, for every dollar China earns, there are only two options: (i) move the dollar out of the country by buying assets overseas, this explains why China is the largest holder of US Treasuries; (ii) printing more RMB domestically, this effectively has flooded the Chinese economy with abundant liquidity.
I think it is fair to say that Chinese economic growth in the past decade was really driven by liquidity. China has a M2/GDP ratio of 2X, higher than the US 1.6X. There is nothing wrong with that as I believe all economies in the world are liquidity-driven, in its simplest form. But there are two types of liquidity: good and bad.
Good liquidity is when a company is chasing after projects with good return on capital, this usually happens when a company has access to scarce resources or is capable to offer premium products which few others can copy.
Bad liquidity is that companies will chase after expansion and new ventures purely on the fact that there is liquidity available, and the decision is made irrespective of return. I am afraid this is the common phenomenon we see in China today. Supply exceeds demand in many areas, such as steel, aluminum and cement.
I think it is fair to say that QE policy worsens the inflation situation in China and in many parts of the world. In fact, inflation and internet have already toppled a number of governments in the Middle East and North Africa . Today, “inflation” is the key word in Chinese newspapers, but it will fade away towards the 2H 2011 and people will start talking about economic slowdown.
Benny Wong, head of research at a Chinese company in Hong Kong, continues his commentary for Equities this week. Benny thinks the Euro debt crisis is manageable for the medium term, which will be good news for Chinese stocks in Hong Kong because it will restrain growth in the U.S. dollar.
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