The Whaley Report: The fortune you seek is in another cookie


Looking at equity markets around the world, you would think we were living in a time of strong economic growth and prosperity. On Thursday in the US, the S&P, the Nasdaq Composite and the Dow, all hit concurrent all-time highs for the first time since December 31, 1999. In the Eurozone, equities are trading back where they were before Brexit, and in emerging markets, equities from Asia to Latin America are partying like its 2007. The problem is that equity markets can be like a late night “wealth building” infomercial. They lure you in with sweet talk about easy money and the good life. The reality is that buying equity markets when these events last occurred would have left your portfolio looking like the “after” photo of someone who’s been on crystal meth for five years.

The last time these US indices hit concurrent highs, all three went on to crash, losing 20% or more, over the following 12 months. It took the S&P and the Dow Jones seven years to get back to that December 31 high, and the Nasdaq required 14 years. Buy and hold anyone?!

Despite the fact that European equities have shrugged off Brexit, it did in fact occur and the profound ramifications will ripple deep and wide. Hell, the vote itself took 12% off of the Eurostoxx Index in just two days.

Emerging markets gained 40% in 2007, only to get shellacked in 2008 to the tune of a 61% decline.

The lesson here is to be wary of equity markets that go up relentlessly when the underlying economics aren’t keeping pace. In fact, China is an excellent example of this right now.

Chinese Foooood
The iShares FTSE/Xinhua China 25 Index, FXI, is a Chinese equity ETF that tracks Chinese stocks that trade in Hong Kong. FXI is up 16% since Brexit and is trading at nine-month highs. The equity markets are indicating that all is well, but one peek under the hood reveals something very different. Watching last week’s deluge of data made me feel like I was in the Chinese FOOOOOD scene from “Dude, Where’s My Car?”

And then…Trade Data
Chinese exports contracted again in July and have now contracted in 16 of the last 17 months. Keep in mind that this period of contraction has occurred alongside a 6% slide in the Yuan. This means that the currency devaluation has done absolutely nothing to help exporters and it also shows you just how weak global demand really is currently. But it’s not just demand “out there,” Chinese imports have now contracted for 21 straight months, showing how horrible domestic demand has been for almost two years. Is it any wonder that Chinese economic growth is at its lowest point in 25 years?!

And Then…The Big 3
The Big 3 have all been in a downtrend for the better part of five years and July’s numbers showed more of the same.

Industrial production peaked in 2010, never getting back to the pre-Crisis glory days of 20% growth. It has been careening lower ever since and has been in the mid-single digits since late 2014. Besides the occasional monthly increase, IP can’t sustain any upward momentum. July’s data confirmed this trend, showing that once again IP has slowed from the previous month.

Retail sales have also been a train wreck. RS peaked back in 2011 at 20% growth and yes, you guessed it, it has been in a downtrend ever since. July’s 10.2% annual growth rate is not only half of what it was five years ago, but it’s also just above the all-time low in sales growth. This just confirms what the import data told us earlier about Chinese consumers, they’ve vanished.

Consumers aren’t just saving their own cash, they’re saving the cash of the corporations they run as well.

The latest fixed-asset investment numbers show that private investment in China looks like the final scene from Thelma and Louise. Not to geek out, but Chinese fixed asset investment tracks spending by both the government and the private sector on things like factories, roads, power grids, and property.

This isn’t going to shock you but the overall FAI peaked at a 33% growth rate back in 2009 and has been averaging 12% for the last two years. July’s reading came in at a red hot 8.1%. That’s a 75% decline in the growth rate in just seven years!

But the real story is that the growth rate of private investments has fallen from 11% in January to just 2.5% in July.

So Chinese consumers aren’t buying stuff and the corporations they run aren’t investing, that’s a real problem going forward. Make no mistake about it, China is falling into a liquidity trap. Investors, both individual and corporate, are hoarding cash because they don’t trust the economy and neither should you.

And Then…Yields
Last week marked the lowest 10-year yield on newly auctioned Chinese government bonds since 2004. The record low yield was caused by both foreign demand and a healthy amount of domestic demand for the sovereign bonds. Consumers are hoarding cash and they are going into government bonds because China is experiencing its own flight-to-safety. The corporate bond market has recently seen a spike in defaults which has investors skittish. They’d rather be in government bonds with the economy on the ropes rather than be exposed to an increased default risk in corporates.

And Then…Equities
Will the real Chinese equity market please stand up? The SSE Composite Index, which is an index of all stocks that actually trade in China on the Shanghai Stock Exchange is mirroring the economic reality better than its Hong Kong equity index counterpart, the Hang Seng, which I discussed earlier.

The SSE Index has bounced just 7% since Brexit and has been trading sideways since December. In fact, from a cumulative return perspective, SSE has gone nowhere since April 2011. That’s got to hurt if you’re a buy and hold investor in China, five years without a return! five years is an interesting time frame, isn’t it? That’s the exact time frame over which all of these Chinese economic data points have been deteriorating and the domestic stock market has gone nowhere.

No and then! No and then!
Don’t let the bright lights of all-time or multi-year highs in equity markets lull you into a false sense of security. There are certainly times when equity markets hitting new highs represents the fact that economic growth is robust and the world is in a cycle of prosperity. However, now is not that time.

It’s time to refuse to play Chinese Foooood mind games. China is in real trouble right now and by association so is the rest of the world. The rest of the world can’t decouple from China, and the US’s weak growth can barely support itself much less carry everyone else.

Anyone buying equity markets at these levels is bound to get hurt. Their only hope is if the global economy can catch up, quick, fast, and in a hurry. But hope is not a successful investing strategy.

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