When assets are priced with record levels of optimism, reality will disappoint. As Dr. Marc Faber said recently “the art dealers are bullish on art, the commodity traders bullish on commodities, the real estate guys bullish on real estate, the stock traders bullish on stocks, everybody has something to buy.” Therefore the wise contrarian strategy is interest-bearing cash. Over the next few years, most assets will fall in value as risk returns to the market and leverage is unwound. In the future, credit will be extended with greater caution.
“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.” – Robert Frost
As billionaire currency trader George Soros said about financial cycles: “the only surprise is that we are always surprised.” For instance, after Reconstruction, signs of railroad stock speculation appeared in the U.S. The popular focus of the day was on easy money, betting, speculation, and credit. In 1873, the speculative bubbles burst and the economy fell into a depression. The print below is from that time period:
The way to grow poor. The way to grow rich. Lithograph by Currier & Ives, 1875 from Pictorial Americana.
Cash Rich and Debt Free China
An economy reliant on debt and speculation is not sustainable. This is as true now, as it was back then. It does not bode well for the United States. Parts of Asia however, especially China, are cash rich and debt free. Their middle class is just beginning to emerge. Just as the crash of 1929 marked the transition of the U.S. economy from the ‘factory’ to the ‘finance’ phase, so this year’s crash will mark China’s economic progression.
Looking at the chart above provided by Elliot Wave International, the ‘idealized’ long term wave pattern suggests a major sell-off for the United States. In our last article, we discussed many reasons why investors should be selling most assets at this time. The U.S. stock market will struggle sideways for many years under the burden of debt, the deleveraging of its economy, and the weakening of the U.S. dollar. China and other Asian countries, currently in the ‘factory’ phase (similar to the U.S. in the 1920’s), will also undergo a significant correction over the next few years. However, as the Chinese begin to develop consumerism, especially when fueled with debt (‘finance’ phase), their markets will significantly outperform the U.S.
Why Now Is Not the Time To Buy
The “Skyscraper Indicator”, used by Edward Dewey in the 1940s, correlates human optimism to the number of high-rise buildings erected. Simply put, when humans are optimistic, they build toward the sky. Major economic downturns usually follow. Examples include: Empire State Building proposed in 1929, Petronas Towers in Kuala Lumpur in 1997 (Asian Crises of 1997), and Burj Dubai in 2003 (the Dubai market is now down over 78% since last November). Now, according to the China Daily, “at least 3,000 high-rise buildings have been built in Shanghai with another 2,000 in the works. Shanghai is also home to China's tallest building and a new building now under construction will be the world's tallest.” This indicator would imply a major sell-off. Recent reports from China describe novice investors creating hour-long lines outside of stockbroker offices. The two mainland Chinese markets are “running at triple the daily volume of just last year.” In manias throughout history, waves of neophytes are the last to join a market before it crashes. Also in Asia, the Vietnam stock market is up ~40% in 2007 and ~180% since 2006. These signs of speculative fervor warn an investor that it is time to sell. Let’s take a look at two Asian stock index charts:
The Hong Kong Index and Straits Times (Singapore) Index wave forecasts from Elliotwave.com imply harsh “C” waves down with losses greater than 50% over the next few years. After this major correction, these Asian indexes would complete sideways trading roughly a decade long. Our contrarian analysis also indicates that the U.S. dollar will have a sharp rally during this period. Few investors, foreign or domestic, would be willing or able to invest in these markets at that point. At the market bottom, fearful investors would be scrambling for cash. At that point, we will go against the emotional crowd once again, by advising the purchase of certain undervalued Asian indexes. But in the meantime, asset preservation with cash is the correct strategy.