The Bubble Is Dead. Long Live The Bubble.

Editor’s Note: This is an article that expresses our personal opinions about global issues and comments made on Television and in Print.  It is NOT intended to provide any investment advice of any type whatsoever.  No one should base any investing decisions or conclusions based on anything written in or inferred from this article. Investing is a serious matter and all investment decisions that should only be taken after a detailed discussion with your investment advisor and should be subject to your objectives, suitability requirements and risk tolerances.

In October 2007, we had written in another setting that 
In our opinion, China has been the biggest bubble of them all. China is critically dependent on the $40 billion of capital flows it receives every month. This capital is being used to create huge overcapacity in almost all global industrial sectors. This, in turn, has created a bubble-like rally in commodities and commodity related stocks supported by forecasts of limitless growth in China. This reminds us of the story of Fiber in 2000 when Global Crossing proclaimed their vision of limitless demand of fiber. When telecom equipment companies slowed down their buying of fiber, the scarcity of fiber rapidly turned in to a huge glut that is still with us.”

In other words, the belief in the limitless growth of China is today’s religion for growth investors, just like the belief in Fiber and Telecom was to the growth investors of 2000.

We recall a presentation by Global Crossing in early 2000 to a crowded ball room in Manhattan in which the CEO said that the growth of fiber will remain strong for the next hundred years because of insatiable demand for telecom capacity. 

If you doubt the parallel to today’s belief in China, just listen to what Peter Kenney of Knight Equities said to Erin Burnett of CNBC in her “Street Sense” segment on Thursday, May 7, 2009.

In this segment, Mr. Kenney recommended a security that, in his own words,  is “an infrastructure play that China (growth) is and will continue to go on for the next 100 plus years.”
(You can hear Mr. Kenney say this in utter sincerity in the clip

Trading Patterns of Bubbles

The past eight weeks or so have featured an explosive rally in Emerging Market Stocks, Commodity/Natural Resources Stocks, Small Cap US Stocks, all categories that are grouped under the term risk assets.

These are exactly the same types of stocks that went to the moon during the Global Liquidity Global Growth 
(GLG2) bubble of 2006-2007. During the bust in 2008, these stocks cratered and went to their lows in early March 2009. Now, in the past 8 weeks or so, these stocks have made a tremendous comeback.

This trading pattern reminds us of the explosive rally in the first half of 2001 in which technology stocks and small cap stocks staged a tremendous comeback. Unfortunately, that rally ended in the summer of 2001 and these stocks went to new lows in 2002. When a new bull market began in 2003, technology stocks did not participate in that four-year bull market. For example, Cisco Systems, the safe, large cap darling of the tech bubble is still below $20, down 75% from its 2000 high around $82. In fact, this past week, Cisco Systems again disappointed investors when it released its earnings.

Will the current rally in GLG2 stocks suffer a similar fate? Only Time will tell. But, if past bubble patterns hold, then this new mini-bubble rally will end. The GLG2 stocks are then likely to go down and stay down just like the telecom and fiber stocks did after mid-2001.

Faith in China

We mean it when we say that faith in China is today’s religion for GLG2 investors. A quasi-religious belief like this is really what makes a bubble. A bubble is created when people believe that something new is happening in the world, something so dramatic and different that it will last forever. This was the case with internet and telecom (internet’s backbone) ten years ago. Telecom was going to usher in an era of limitless growth created by a new, new thing, the Internet. CEOs of telecom companies told analysts and TV anchors of this huge limitless growth and these analysts/anchors bought it.

Today GLG2 investors believe that Chinese growth will be limitless and lead to great prosperity for companies that sell infrastructure products to China. As Peter Kenney said to Erin Burnett, you have to buy his security “especially if you believe in the efficiency of the stimulus package being introduced in China”.

Peter Kenney seems to be a late-comer to the China faith. In our opinion, the leader of this 2009 born-again believe-in-China faith is Jim Cramer of CNBC.
On Tuesday, January 6, 2009, Jim Cramer talked about the power of China’s stimulus plan – the plan that intends to put millions of unemployed Chinese to work. Jim Cramer said that day China is the engine that will pull America and the global economy out of our mess.  In his own style, Cramer asked on that day “Could Capitalism be saved by Communist China?” (See our article “Jim Cramer – Balanced Thinker but Wrong on China” – January 9, 2009–balanced-thinker-but-wrong-on-china.aspx ).

After the great rally in March-April, Jim Cramer has become a fire and brimstone preacher of the believe-in-China faith. If you doubt us, watch the clip of his “Hallelujah China” type of conversation with Erin Burnett on April 29, 2009. Cramer spoke of the China’s stimulus package as if it were manna from heaven and asked viewers to buy Corning, Whirlpool and GE because they sell to China.

Jim Cramer actually said to Erin Burnett
“your interview (with Chen Deming, China’s Commerce Minister) may be the end of whatever appliance glut that may be there”. Later in this segment, Cramer told Burnett “The Chinese are pulling everyone out” of recession. You have to watch this conversation to see what quasi-religious exuberance about China sounds like. ( ).

We have to give credit where credit is due. The past 8 weeks have been a testament to Jim Cramer’s thesis that China’s stimulus is real and will lead the world’s equity markets. If you followed Cramer’s advise from March onwards, you made “mad money” as well as “fast Money”. But, if you took his advice on January 6, 2009 when he gave it and bought the China-related stocks at that time, you are up about 10% after a crazy roller coaster of being down huge and then up huge.

If the current rally in China-related stocks continues and proves to be a new bull market, then Jim Cramer once again will have made a great call. But, if the China-related stock rally fizzles out and these stocks go down & stay down, then Jim Cramer will once again have made a terrible call. Time will tell.

Other views on China and Chinese stimulus

Peter Kenney clearly believes in the efficiency of the Chinese stimulus. Jim Cramer clearly believes that China’s stimulus is the real thing. Joe Terranova of CNBC’s Fast Money is so crazy about China that he actually made an outlandish (and untrue) claim on National TV that the US Fed was following China’s lead in buying the same treasury securities that China was buying.

Many knowledgeable observers disagree and wonder whether the Chinese stimulus package is leading to a banking crisis in China. The Wall Street Journal published a detailed story on April 21 titled “China Credit Boom Spurs Concern”. The article discussed concerns in China that the stimulus might have been diverted into Chinese asset markets and could end up being wasted. (

Bloomberg published an article on April 30 about Chinese Banks. This article quoted Wen Chunling, a Beijing-based  analyst at Fitch Ratings, as saying “We suspect some of the banks may have compromised their risk-management and risk-aversion attitude to meet targets and government expectations….This will lead to a rebound in non-performing loans in the next few years.” (see

In other words, Chinese banks may end up loaded with bad debts contrary to what Chinese Minister Chen Deming told Erin Burnett on April 29. In that interview, Mr. Deming said that the problems in China were different from those in the US because the American Banks had bad debt problems but the Chinese financial institutions did not. (see the interview at ).

Is it possible for Minister Deming to not know the reality about China’s banks? As analyst Wen Chunling says, it may take as long as three years before the increase in non-performing loans is fully reflected in bad-debt statistics. As  Wen Chunling explains “That’s in part because China’s loan-classification system requires subjective assessments, giving lenders room to maneuver”

This reminds us of Japanese Banks in 1990. At that time, Citibank was virtually insolvent, most other American banks were in trouble and the US had a huge banking crisis. In contrast, the Japanese Banks had become the largest banks in the world and were perceived as bastions of safety and credit quality. Later, we discovered that the Japanese Banks were loaded with bad debt and no one knew because the Japanese banks did not have the rigid disclosure requirements that US banks had.

Today, the American Banks are again in trouble and loaded with troubled assets. Every one in the world knows this and is sick of hearing this. In contrast, the Chinese Banks have become the largest in the world and are perceived as strong without any credit problems. Remember that Chinese Banks are controlled by the Chinese Government. When the government tells Chinese banks to lend, the banks can only ask how much and to whom. So frankly, we are more inclined to believe the realism of Wen Chunling than the assurances of Minister Deming. In other words, the balance sheets of Chinese Banks might be so bad that Citibank might look pristine in comparison.

This is not a minor problem. We understand from knowledgeable sources that the valuation of the Chinese Banks today exceeds $500 billion or 16% of Chinese GDP. This is an extraordinary figure. This is the sort of stuff that leads to limitless deflation, not limitless growth. Just ask Japan.

Are Chinese Leaders smarter and wiser than American leaders?

Yes and absolutely yes – is the message we hear every day on CNBC. Americans see their elected representatives acting crazy and talking nonsense on TV; they see their officials lampooned by TV comedy shows and cartoonists. In contrast, the Chinese leaders are distant enigmatic figures. They give short terse interviews if at all and TV anchors like Erin Burnett are very careful to not give offense by asking penetrating questions.

The entire world has witnessed the dramatic growth of China over the past few years and so the Chinese leaders are treated with respect bordering on reverence. This is why Peter Kenney of Knight Equities and Joe Terranova of CNBC’s Fast Money proclaim their deep belief in China’s leaders to CNBC’s viewers. Even Jim Cramer, who dislikes the communist regime, tells his viewers that he believes in the efficiency of the Chinese leadership.

In our opinion, they are wrong, totally wrong. We think that the Chinese leaders live in a cocoon and are not subjected to any intellectual opposition. Their policies have been very successful during the past few years and now they seem to be drinking too much of their own concoction. They seem to believe that they are smart and their economic system has worked well while the American leaders have behaved stupidly and the American economic system is in trouble. Their actions are beginning to reflect this arrogance. This is why China today is behaving differently than it behaved during the past few years.

Unlike the Chinese system, the American System is mostly free and highly competitive. Unlike Chinese policy, American policy is made mostly in public with strident, sometimes vitriolic, debate between proponents of radically different points of view. This is a flawed, highly inefficient system that miraculously works. This slow and flawed system allows many small mistakes but protects American society from making the really big
economic or social policy mistake.

In contrast, autocracies do not make many small mistakes, but end up making the truly huge mistake. Chinese leadership has already shown this propensity. The 1970s were a period of commodity inflation. The dominant thinking at the end of that decade was that the commodity crisis was caused or exacerbated by explosive population growth. Countries with large populations were told to limit their population growth because the earth’s resour
ces were limited.

Chinese leaders became converts to this thinking. As autocrats, they decided and implemented their draconian “one child” policy with efficiency. This has turned out to be an enormous mistake. Chinese society is now aging so rapidly that by 2050, there may be only two working-age people for every senior citizen, compared with 13 to one now. This will be a retirement crisis and an economic crisis of massive proportions.  

Today, Chinese leaders are obsessed by inflation just like all the momentum players in the world. The Chinese leaders have bought into the fallacy that America is overreaching in its efforts to stem deflation. So, in stark contrast to America, Chinese leaders are trying to hoard commodities and natural resources in their attempt to protect against inflation.  Imagine a nation with severe, severe overcapacity hoarding commodities.

In our opinion, this will be end up as one of China’s major mistakes. Their fight against perceived inflation will actually end up causing deflation. Like everything produced in China, Chinese deflation will end up spreading around the entire world. As Joe Walker, Founder & CEO of Asianomics, told CNBC Asia’s Martin Soong “Policies being undertaken by China are worst responses to global crisis yet”.

Is there a Chinese Jim Cramer who can rant “They Know Nothing” about the Chinese leadership on Chinese National TV? We doubt it. That may be China’s loss.

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