Skyscraper Index Bodes Ill for China

04/24/2012 8:15 am EST

Focus: GLOBAL

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

If you don’t think there are enough market indicators out there, just wait a while and there will certainly be another handful cropping up like toadstools after a rain. But some actually have some value, writes Ian Wyatt of The Daily Profit.

Investors should take care to differentiate between correlation and causation. Just because two variables move in a recognizable pattern (correlation) doesn’t mean one influences or is predictive of the other (causation).

You might be familiar with the Super Bowl indicator: If an old AFL team wins the Super Bowl, the stock market usually declines over the upcoming year. If an old NFL team wins, the stock market typically rises over the year. The indicator actually boasts an 80% accuracy rate.

The Super Bowl indicator is a correlative indicator at best. Obviously, a football team doesn’t influence the stock market, which means it isn’t causative.

If I regress the times I scratch my nose first thing in the morning against finding a stock being up 80% of the time, I’ve found a correlative relationship. I’d be foolish to implement an investing strategy based on stock market moves and nose scratching. Otherwise, I’d end up scratching my nose a lot.

Other times, though, correlations are indicators of causative relationships. The Skyscraper Index is an example. The Skyscraper Index, first noticed by economist Andrew Lawrence and subsequently tied to business cycles by economist Mark Thornton, reveals an influential relationship between the world’s most towering buildings and impending market doom. The index has gained currency among investors in recent years.

Granted, the Skyscraper Index isn’t perfect; no single indicator is. It failed to predict the severe recessions of 1920-21 and 1981-82. That said, I think the reasoning behind the index foreshadows ominous events in China.

Real estate is an obsession in China. Its largest skyscraper, the Shanghai World Financial Center, was completed in 2008, but China has built a plethora of skyscrapers since. In fact, China has the largest number of skyscrapers in the world. Barclay’s Capital reports the country is home to half the world’s skyscrapers—defined as buildings above 787 feet.

The 1,082-foot Longxi International Hotel, completed last November, is one of the latest additions. It’s also one of the more ostentatious, if not perplexing. The Longxi includes a revolving restaurant, a rooftop swimming pool, mall, theater, spa, and an ox made of a ton of gold that’s perched on the 60th floor. All this in the Jiangsu province—population 50,000.

So what are skyscrapers trying to reveal? Andrew Lawrence mentions over-investment, monetary expansion, and speculation as possible foundations for building highrises on a gargantuan, uneconomical scale.

I see monetary expansion, which stimulates optimism and excessive speculation, as the driving factor behind the Skyscraper Index. You see, low interest rates and easy money promote investment, and thus inevitably promote investment in the hot sector.

China’s monetary policies have been as easy as any country’s over the past decade. China’s long-standing loose monetary policy means that inflationary credit expansion has fueled a great deal of the rapid growth of the economy; much of that newly lent money has found its way in real estate.

More ominous, China shows no signs of tightening the purse strings. At least here in the States, there is debate and dissension on the Federal Reserve’s monetary stimulus. Not so in China.

Bloomberg reports China’s government wants more money and has committed to cutting the reserve/deposit ratio for lenders. That means further loosening of a monetary policy that already points to 13.4% year-over-year growth in the money supply this year.

China’s drive to pump out more money is a preemptive strike against a slowing economy. The latest quarterly estimate shows China’s economy growing at an 8.4% annualized rate, the lowest in 11 quarters. A slowing economy gives the Chinese government even less inclination to tighten the monetary spigot.

I see a lot of risk in China. Easy-money binges rarely end innocuously. China’s government gives me no reason to believe its easy-money binge will end any better (and could possibly end a lot worse) than other money-fueled binges.

Our own Great Depression was the culmination of a decade of relentless monetary growth that lead to massive bubbles in both the stock and real estate markets. When the bubbles burst, in 1929, the finishing touches were being put on three record-breaking skyscrapers in New York.

Granted, China doesn’t have a record-breaking skyscraper in size. Instead, it has a record-breaking scope of skyscrapers, which is on a scale no other country has come close to approaching.

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