Shanghai Down, Not Quite Out

07/19/2012 12:00 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

A rebound in Chinese home sales has given Shanghai stocks only a modest lift from three-year lows, writes senior editor Igor Greenwald.

After the historic real estate run-up crested and the prices began their long retreat, authorities started to reverse the prior credit tightening. And for a while investors cheered, as optimism lingered long after outright greed went into hiding.

But there was no escaping the reckoning with years of malinvestment, fraud, and excess, and the reprieve didn’t last long. And it was only as the pyramid of leveraged housing credit finally crumbled that the true scale of the problem emerged.

That was the US in 2007, and quite plausibly China in 2012 as well, granting that every bust is different. In the US, hopes for a housing recovery had turned to dust months before the Federal Reserve began lowering interest rates. In China, things are tentatively looking up only after two cuts to the benchmark rate.

Of course, the buying is currently mostly limited to first-time home buyers convinced they’re getting a bargain. And they’re not necessarily the most streetwise crowd.

“Home prices in big cities such as Beijing and Shanghai will never go down,” one recently minted homeowner told Bloomberg, with the certainty that will be instantly familiar to the residents of Las Vegas and Madrid.

Chinese stock-market investors, on the other hand, are much more skeptical than their US counterparts had been five years earlier, dunking the Shanghai Composite Index to lows not seen since March 2009.

It’s trading below ten times forward earnings, because those earnings are widely doubted, despite official reports of only a modest economic slowdown. Chinese stocks did gain almost 2% over the last three days, reversing Monday’s drubbing, so that’s something.

But it’s nowhere near enough to suggest that China has absorbed the overhang of uneconomical fixed investments made over the last three years. In fact, it’s now contemplating more of the same at the first sign of economic trouble. The reckoning still lies ahead, as Michael Pettis capably argues.

And meanwhile, Spanish bond yields are back above 7% as the police guard lawmakers debating the latest batch of debilitating cuts. Contrary to the Spanish government’s claims, commitment to such bloodletting isn’t stimulating the appetite for Spanish debt—the most plausible buyers, Spanish banks, are mostly tapped out, and hoarding what cash remains to cope with the deflationary spiral.

There’s no credit, no end to the income drain, and no realistic hope of fully repaying the debts incurred in happier times. Worse, the inadequate aid extended by Europe relies heavily on contributions from Italy, which of course is in the very same leaking boat, ignored for the moment only because Spain’s straits are that much direr.

In the absence of a drastically cheaper currency or a huge consumption boom in northern Europe, the depressed south will continue to struggle. Even if Germany one day relents on jointly guaranteed debt, it would be addressing only a symptom of the payment imbalances tearing Europe apart.

With the US facing its own fiscal cliff and China suffering from serious indigestion, there is no credible external source of demand to rescue Europe from its failed policies.

In fact, the latest quarterly letter to clients from hedge-fund giant Bridgewater Associates estimates that in recent months global growth has slowed from 3.3% to 1.9%, dragged lower by the 80% of the world’s economies that are decelerating, including all of the majors. “The breadth of this slowdown creates a dangerous dynamic because, given the interconnectedness of economies and capital flows, one country’s decline tends to reinforce another’s,” Bridgewater notes.

For the moment, this risk has been obscured by hopes for monetary easing, fiscal stimulus, and earnings surpassing reduced expectations, even as revenue disappoints. But the economic trend is still not the stock investor’s friend while the official countermeasures unveiled to date fall far short of what will ultimately be required.

Beijing real estate would look more attractive if buyers didn’t think it would never devalue. And stocks might prove a better bet when their sellers are once again cursing the central banks for not doing enough.

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