USA & China: Risks of a change in Economic Time

Friday, December 16, 2016 // Written by Enzio von Pfeil

America's Economic Time® keeps improving; China's keeps worsening.

  1. America's Economic Time®.  For the past year, America's Economic Clock® has moved from an excess supply of money/excess supply of goods to an excess DEMAND for money/excess DEMAND for goods. This was reinforced by this Wednesday's  25 basis point hike in Fed Funds.  The Fed's endorsement of America's healthier Economic Time® has to be good for her corporates' earnings outlooks and thus stock market.
  2. American risks.  According to today's Financial Times (FT),  in American "...about 9.3million borrowers may be at risk of defaulting on at least one type of loan (e.g.  on  subprime credit cards) as a result of the fate increase, according to TransUnion (which keeps an anonymized database of 220 million borrowers."  I imagine that the bulk of such subprime credit card  loans have been bundled into junk bonds and on-sold; thus, what happens when the constituent borrowers of such bundles go belly-up?   To mind spring wobbly loans for things like mortgages,  cars and education... 
  3. China's Economic Time®.  According to the same FT, "The PBoC has guided Chinese money market rates higher in recent weeks, partly in anticipation of the Fed move."  The other reason for said rate hike has been to brake  that ever-drooping RMB, which has fallen by nearly six per cent  yea-to-date. This means that of late, China's Economic Clock® has moved from an excess supply of money / excess demand for goods to an excess DEMAND for money/ excess supply of goods. This is bad for her stock market, as the earnings outlook has to worsen against the backdrop of an excess supply of goods, 
  4. Chinese risks.   Disregarding what the bull in the China shop, Trump, has done to the stability of the "One China" policy, China's key economic risks stem from her pronounced capital outflow. First, this depreciates the RMB even more, creating  two risks: imported inflation as well as debt defaults: too many Chinese have mismatched their currency liabilities, i.e. they are repaying (ever-stronger) dollar debt out of (ever-weaker ) RMB sources. No prizes for pointing-out that the stronger dollar results in ever-higher RMB debt servicing of these heroic currency mis-matchers. Secondly, with the RMB flagged to wilt below 7.5- 8.00/US dollar, expect imported inflation. This could translate into Chinese stagflation during 2017.  Finally, in order to defend the RMB exchange rate, the PBoC will have to tighten even further, thereby exacerbating China's excess demand for money. That, in turn, bodes poorly for her own as well as Hong Kong's stock market: we are, after all, the water skiers off the back of the Chinese speed boat.
  5. Implications for the Evidence-Based Investor.  Fama-French's three factor model suggest that return variability of stock portfolios can be explained by three factors: the market itself, the size of the company being invested in, and the value of the company being invested in.  By far, the factor most influencing returns, however,  is the market itself (which is what Sharpe et al's Capital Asset Pricing Model was about in in the 1960s). Thus, Evidence-Based Investing favours the US market on account of her Economic Time®, and does not favour the China's and Hong Kong 's stock markets.


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