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Kurt Shrout
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Kurt has a BA and MA in Communication and over 20 years of business experience, almost always serving as a project or program manager, director, or consultant or as an analyst. He lived and worked in many different locations in the U.S., London, England, and Hong Kong. He has experience in at... More
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  • China Housing Prices—Bubble or Bull?
    (I researched and wrote this article last weekend. It was not published by Seeking Alpha. For multiple reasons, I am not going to revise it and resubmit it for publication. I hope some of you find it useful.)
     
    There has been a great deal of talk lately regarding China’s supposed or actual housing price bubble. Four key questions should be answered and, then, monitored regarding this topic.
     
    1)      Does China have a housing price bubble?
    2)      If yes, what is the nature and extent of the bubble?
    3)      Will the bubble be eased down or will it burst?
    4)      What will be the impact of the easing down or bursting?
     
    In December of 2010, the International Monetary Fund (IMF) release a Working Paper entitled “Are House Prices Rising Too Fast in China?”. Multiple information sources were used in constructing this paper. This paper affords us with an excellent opportunity to acquire an accurate understanding of the Chinese housing market through mid-2010.
     
    Per the IMF Working Paper:
     
    • “First, on degree of price misalignment, we find that, as of mid-2010, house prices are not significantly overvalued in China as a whole. However, the mass-market segment in a number of coastal cities—but most clearly in Shanghai and Shenzhen—as well as a few inland cities may be in the early stages of excessive price growth. Early signs of price misalignment can also be detected in the luxury segment in Beijing and Nanjing.”
    • “Second, we find that over the past decade, when misalignments in house prices have occurred, they have been corrected relatively quickly.” “This constant correction of house prices is unlike the behavior observed in several industrial economies before 2008—especially the U.S., New Zealand, and France—where deviations from benchmark prices tended to persist far longer, allowing for an accumulation in vulnerabilities, ending in a large and abrupt adjustment.”
    • “Third, the policy measures taken by the Chinese government in April 2010 appear to have had some impact on price growth. The gaps between market and fundamentals implied prices have become smaller in a few cities. However, in a few cities, these market and policy measures do not seem to have been very effective in bringing prices back toward fundamentals. In particular, prices in the mass market segments in Guangzhou, Tianjin, and Shenzhen recently seem to have remained persistently misaligned.”
    • “Given the awareness of China’s authorities of the risks excessive property price growth poses and their experience in containing them, the likelihood of financial instability precipitated by a housing price bust seems small.”
     
    What has happened since mid-2010?
     
    The National Bureau of Statistics of China (NBS) provides monthly updates on housing price increases or decreases. There was well-founded criticism of the accuracy of these statistics. Recently, these statistics were improved via better and wider data collection techniques and cross-checking. Further improvements will be made this year.
     
    (You should avoid jumping to high regarding this statistical accuracy issue. Remember, China is still a developing nation. More of these kinds of issues exist in developing nations. Also, even well developed nations like the U.S. produce some faulty statistics. For example, the U.S. Unemployment Rate greatly understates the actual unemployment situation, and there is no significant movement toward improving this statistic. The point here is not to belittle the U.S. The point is to get people to view China’s statistical issues, where such statistical issues actually do exist, in proper context.)
     
    NBS:

     
    New Housing Prices:
     
    “Comparing with the same month of last year, the sales price of 68 cities in 70 large and medium-sized cities went up, that of 2 cities went down. Of the total, that of 10 cities grew more than 10%.”
     
    Existing Housing Prices:
     
    “The sales price of 65 cities in 70 large and medium-sized cities went up, that of 5 cities declined. Of which, 6 cities rose above 10% comparing with the same month last year.”
     
    There is no mention of an inflation adjustment in regard to these statistics. They appear to be unadjusted for inflation. Also, in viewing these statistics, it is important to keep in mind that sales of new homes far outnumber sales of existing homes in China.
     
    The IMF Working Paper named six specific markets about which there was a concern—Shenzhen, Shanghai, Guangzhou, Tianjin, Beijing luxury, and Nanjing luxury. In this most-recent NBS data, Beijing had a general (not just luxury) year-over-year new housing price increase of 6.8%. All of the other market-of-concern cities had year-over-year housing price increases of less than 6.8%.
     
    China has a housing price bubble forming in certain markets; and those forming bubbles are in the process of being combated by the Chinese government. In the last year, China has taken numerous steps to address, or that will serve to address, the forming bubbles. These steps included:
     
    • Raising down payment requirements.
    • Limiting purchases of first, second, and third homes.
    • Introducing trial property taxes in Shanghai and Chongqing that can serve as a model for a wider introduction of property taxes.
    • Raising bank reserve requirements eight times.
    • Raising the benchmark interest rate three times.
    • Increasing the foreign exchange rate value of the Yuan on multiple occasions.
     
    Additionally: “China will build 10 million affordable homes in 2011, as part of a plan to build 36 million properties for low-income families during the 12th Five-Year Plan period (2011-2015). The total investment this year will be 1.3 trillion Yuan ($196.9 billion), said Qi Ji, vice-minister of housing and urban-rural development... ‘The government will provide affordable housing projects with land for free, which we didn't include in the costs’, said Qi.” “Qi said the government will provide 500 billion Yuan for the investment and the rest will be raised from the markets by non-governmental organizations.” Construction of 5.9 million government-subsidized homes began in 2010, and 3.7 million have been finished, according to the ministry.” (Source)
     
    This will also serve to hold down or reduce housing prices in China.
     
    There are other factors in play here as well.
     
    • There are limited other-than-housing investment options in China. Investment options for Chinese citizens are slowly increasing over time, so this issue is in the process of being slowly addressed.
    • Chinese citizens have a high savings rate and are less prone to spend. (Investing in a home is a form of saving.) This will become less true as China strengthens its social safety net, which it plans to do, and encourages more consumption, which it has already begun to do.
    • Incomes are increasing more in China. Per a February 28, 2011 report from the NBS: “In 2010, the annual per capita net income of rural households was 5,919 Yuan, or a real increase of 10.9% over the previous year when the factors of price increase were deducted.  The annual per capita disposable income of urban households was 19,109 Yuan, or a real increase of 7.8%.” From 2005 to 2010, price-factor-adjusted per capita disposable urban income rose at a rate of 9.7% per annum. (Source) The rising incomes serve to make higher housing prices more affordable.
    • The availability of mortgage financing is increasing. Medium and long-term, if not short-term, this trend should continue; and it should continue to exert upward pressure on housing prices.
     
    What is the extent of China’s and the world’s financial exposure?
     
    It appears that China’s forming housing price bubble in certain markets is going to be eased or smacked down, versus bursting. China has been taking quality proactive measured steps to address the housing price situation for almost a year now. Also, China has a history of successfully correcting housing price misalignments.
     
    The extent of potential harm is not as great as many people fear. Two reasons for this are:
     
    1. Down payment requirements in China are high. The first home down payment rate is now 30%. The second home down payment rate is now 60%. (About a year ago, these figures were 20% and 40% respectively.)
    2. There are little or no associated derivatives.
     
    On the concerning side, local Chinese governments depend on property sales for some of their revenues. Some of these property sales are for commercial, versus residential, development though.
     
    Per the IMF working paper, “real estate investment now accounts for…around 9 percent of (China’s) GDP”. This 9% figure should include both residential and non-residential real estate investment. A turndown in housing sales and prices in certain Chinese markets will only be detrimental to a limited extent.
    Mar 18 9:37 PM | Link | Comment!
  • Deconstructing the China Construction Myth

    (I finished researching and wrote this article last weekend.  It was not published by Seeking Alpha.  For multiple reasons, I am not going to revise it and resubmit it for publication.  I hope some of you find it useful and/or enjoyable.)

     

    Preamble

     

    In the last year or so, there have been many written articles, video segments, et cetera, suggesting that the Chinese economy is headed for a big fall.  These articles, segments and the like are often so filled with false and misleading information and flawed reasoning that it would be extremely time-consuming to address all of the errors within them.  There are multiple reasons why there is now so much bad information regarding the upcoming fate of the Chinese economy.  Some major reasons are as follows.

     

    • More recently, more people have shorted certain Chinese and Chinese-related investments.  They are concerned with influencing the price of these investments downward.  They are not necessarily concerned with the integrity of the information used to do so.
    • Some Americans simply want to push investment dollars toward the stocks of U.S.-based companies versus the stocks of China-based companies, even though the U.S.-based company stocks are often far pricier.  They are not necessarily concerned with the integrity of the information used to do so.
    • Due to (a) misdirected national pride, (b) an irrational dislike of any system with a “communist” label associated with it—versus a healthy skepticism of all like systems, and, on occasion, (c) racial prejudice, some Americans simply want it to be true that China is headed for a big fall soon.  They are attempting to justify what they want to be true.  This is different than seeking what is true.
    • More and more in America, objective journalism, and the fact checking, et cetera, associated with it, has taken a backseat to what are, actually, advocacy pieces.

     

    In a challenging communication environment like this, how do you get the information you need or want regarding the likely future of the Chinese economy to facilitate your investment decisions?  Two good rules to follow are these.

     

    1)      Evaluate the source.  The source should not be strongly motivated to mislead you in one direction or the other, and they should not have a track record of providing misleading information.  Also, they should be well-qualified to write or speak regarding the specific matter.

    2)      Verify the accuracy of information.

     

    Exercising these principles, I will address some questions regarding the future of the Chinese economy.  I will begin in this article by addressing the China construction myth.

     

    The China Construction Myth

     

    The myth is that construction constitutes a massive portion of the Chinese economy, a far larger portion than is sustainable.  Jim Chanos, president and founder of hedge fund Kynikos Associates, may be the greatest source of this myth.

     

    In a February 10, 2011 segment on CNBC’s Squawk Box, Chanos claimed:  “Construction as a percent of the Chinese economy in 2010…it’s 70%.”  (Source, beginning at the 6:09 mark.)  With a small amount of economic knowledge and common sense, it is obvious that this statement cannot possibly be true; yet neither of the Squawk Box moderators involved in the conversation questioned Chanos’ statement.

     

    A simple “gee, Jim, that can’t be correct” would have sufficed.

     

    Chanos made this same claim previously.  The only difference is that, now, the percentage claimed is even higher.

     

    Chanos isn’t the only source of absurd misinformation on this topic.  Here is a website telling us that the “construction industry contributed 53.1 percent of (the) GDP of China in 2005”.  In the very next sentence, the website tells us that in 2004, (the) industrial sector comprised 52.9 percent of China's GDP”.  Since construction is a sub-component of the industrial sector, the website is called EconomyWatch, and, per EconomyWatch, “EconomyWatch.com is the largest online economics community in the world”, the author and/or editor should have enough knowledge to not continue to publish this clearly false construction industry statistic.

     

    A more extensive Internet search reveals that industry (with construction as a subcomponent) contributed 53.1% of China’s GDP in 2005.

     

    The China Construction Reality

     

    U.S. Central Intelligence Agency, The World Factbook, China, GDP – Composition by Sector, 2010 Estimates:

     

    Agriculture — 9.6%

    Industry — 46.8%

    Services —43.6%

     

    These percentages are consistent with the non-estimate percentages for the years prior to 2010.  As previously mentioned, construction is a subcomponent of Industry.  Also, Industry includes many other things beyond construction—including the vast majority of China’s exports.  It is not vaguely possible for construction to be anywhere near 70% or 53.1% of China’s GDP.

     

    On March 3, 2011, Global Construction Perspectives and Oxford Economics released a new report on global construction.  This new report was sponsored by PricewaterhouseCoopers (PwC).

     

    Per Reuters on March 3, 2011:  “After overtaking the US as the biggest construction market in 2010, China's construction sector will more than double in size to $2.5 trillion by 2020, accounting for a fifth of world construction, PwC said, citing a report it sponsored.”  “The construction sector worldwide currently accounts for more than 11 percent of global GDP and the report predicts that it will account for 13.2 percent of world GDP by 2020.”

     

    This indicates China’s construction sector was sized at less than $1.25 trillion in 2010.  Per The World Factbook, China’s estimated 2010 GDP was $5.745 trillion.  Via the International Monetary Fund and World Bank, a $5.7 trillion estimate is obtained.  This indicates that China’s construction sector was less than 22% of China’s 2010 GDP.

     

    In May 2010, international business research company Freedonia  described Chinese construction as a “7.8 trillion Yuan…industry”.  In May of 2010, the exchange rate was about 6.83 Yuan to one U.S. Dollar.  Using this exchange rate, 7.8 trillion Yuan equals about $1.14 trillion.  This indicates that China’s construction sector was about 20% of China’s 2010 GDP.

     

    According to a December 2010 International Monetary Fund Working Paper entitled “Are House Prices Rising Too Fast in China?, “real estate investment now accounts for…around 9 percent of (China’s) GDP”.  Real estate is a sizable subcomponent of construction.

     

    There are some good reasons why China’s percentage of GDP constituted by construction should be higher than that of the world as a whole.

     

    • China is a developing nation.  Developing nations need to build the infrastructure upon which they can become developed nations.  One of the reasons for China’s greater GDP growth rates in comparison to other developing nations is its better infrastructure.
    • China’s post-economic-crisis $586 billion stimulus package was, by far, mostly construction-oriented.  This package significantly increased 2009 and 2010 construction spending.
    • A lot of Chinese housing from the past is of very poor quality.  Residents of China have a very strong bias toward new, versus existing, housing.

     

    Conclusion

     

    Adjusting downward to eliminate the affect of the stimulus package, China’s construction percentage of GDP appears to be about 18%, versus a world percentage of about 12%. Also, China is a developing nation and has a very strong bias toward new housing.  When analysis is done and discussions take place involving whether China’s construction spending is too great, it should occur in this kind of a context.  Anyone stating figures like 70% or 53.1% of GDP for China’s construction should be put on Ignore.  You may not have a message board option which enables you to do this, but there is always the Ignore button in your head available for use.

    Mar 18 9:33 PM | Link | Comment!
  • U.S.-Listed Chinese Stocks - Gravely Mistreated & Far Undervalued (Part 2)

    A vast array of communication tactics have been used to unfairly characterize the U.S.-listed Chinese stock sector and the stocks within it.  Below are some of the more prevalent tactics.

    (1) Comparing numbers reported to an SAIC entity(s) in China with SEC financial reporting and claiming that, since the numbers don’t match, the company must have exaggerated its revenue or the like.

    In brief, it has become fairly common knowledge among investors in the sector that, for many reasons, these numbers shouldn’t match, and, sometimes, they should not match by a lot.  (For more information:  http://china.fixyou.co.uk/2010/07/on-saic-and-sec-filings.html)  If the numbers don’t mismatch by enough to sufficiently scare investors, a short-side communicator can simply pretend that the numbers for one or a limited number of a company’s subsidiaries in China should match the SEC numbers for the company as a whole.  In defending itself after being unfairly criticized by Muddy Waters, Orient Paper (ONP) explained that a company Muddy Waters referenced in its report in regard to SAIC numbers was not its actual subsidiary, but instead a company with a similar name.  (Source:  http://www.streetinsider.com/Corporate+News/Orient+Paper+%28ONP%29+Responds+to+Report+That+Muddy+Waters+Has+a+Short+Position+in+Companys+Stock/5771103.html)  (Muddy Waters did not issue a related retraction.)  Of course, a short-side communicator does not have to get this fancy, they can suffice with “counterfeiting SAIC documents”, as John Bird (aka Waldo Mushman) was said to have done.

    (2)  Claiming that “reverse merger” means “poorly-vetted” and, therefore, too risky.

    This was a significant issue before “U.S. regulators tightened the rules for reverse mergers in 2005, forcing companies to disclose more information after merging into shell companies.”  (Source:  http://www.reuters.com/article/2010/04/15/us-chinesereversemergers-analysis-idUSTRE63E4TW20100415?pageNumber=1)  Also, once a company does a public shares offering or lists on or uplists to the AMEX, NYSE, or NASDAQ, this becomes even more of a non-issue.  The company did nothing wrong in using the reverse merger process to establish itself as a U.S.-listed stock.  In fact, the process should have enabled them to list more quickly and may have enabled them to do so more inexpensively.  Companies from many countries, including the U.S., use this technique to list.  In fact, Berkshire Hathaway and The New York Stock Exchange “became publicly held corporations by virtue of a reverse merger”.  (Source:  http://www.halter.com/)  Short-side communicators like to make it seem like “reverse merger” is a dirty little backdoor that only Chinese companies use to list in the U.S.  As you can see, this is in no way true.

    (3)   Claiming that the Chinese companies that listed in the U.S. listed in the U.S. because they could not list in China due to inferiority.

    Actually, the opposite is often true.  Some of the best Chinese enterprises have listed in the U.S.  At least once, China simply did not approve any new stock listings for a while.  China did not launch a growth enterprise market (GEM) until October of 2009.  Many of the Chinese companies listed in the U.S. listed in the U.S. before October of 2009.  Even now that China has a GEM, an investment can be a great opportunity and not meet the listing standards for the Chinese exchanges.  (Source:  http://www.businessweek.com/magazine/content/10_48/b4205059211793.htm)  Also, China has overall bank lending limits and tight controls on international currency flows.  This further serves to push good companies toward the U.S. markets.

    (4) Claiming that there is more fraud in China.

    There may be more fraud, about the same amount of fraud, or less fraud in China.  If you don’t believe this, it may be because you don’t know, or won’t admit to yourself, enough of the truth about the U.S. and like countries.  There are many ways in which people try to get you to believe that there is more fraud in China.  One I have been hearing recently is that the Chinese companies have two sets of books, one that they show to the tax authorities and one with the real numbers thereon.  This may have been the case when these companies were smaller.  The more they grew, the less likely it became that this was the case.  How do I know?  Because this is how it is in many countries, including the U.S.  In fact, I worked in a couple of small U.S. businesses.  For one, I do not know whether they had one or two sets of books.  For the other, I know for certain that they had two sets of books, specifically to avoid paying any taxes.  If you need or desire further enlightenment, here is a link to an article regarding Canada that will help.  (Link:  http://www.canada.com/calgaryherald/news/calgarybusiness/story.html?id=aba83332-d0ee-4887-b37c-8dbbfbc44aa9&p=2)

    (5)  Inundating the stock message boards with negative posts.

    Yes, stock and stock service pumpers are also an issue on the stock message boards; but this problem is not nearly as severe as the numerous unfair negative posts that are appearing.  It has become clear to many of us that many posters have been paid to cry “fraud” and the like over and over again regardless of the facts and sound logic.  Not all of the paid or other negative posters are this obvious.  There are many different unethical communication strategies used.  One is to pretend that you are long on the stock (The purpose of this part is of the strategy is to get people to like and trust you.); but then you say you sold because, now, you have learned more.  Then, you claim you are not short on the stock (The purpose of this part of the strategy is to get people to continue to like and trust you.); but you participate on the message board for months more, even though you supposedly hold no position in the stock.  While participating, you support many, if not all, negative comments made regarding the stock, and make many negative comments of your own—regardless of whether these comments are supported by the facts and sound logic.  It is easy to tell that these people are short on the stock and/or being paid to harm the stock price for two reasons.  (1) They supposedly went long with what was, apparently, inadequate due diligence; but now we are supposed respect what they have to say.  (2) Far more importantly, regardless of what they say, they would not still be participating on the message board if they did not have a hidden, illicit agenda.

    (6)  Saying that “if it sounds too good to be true, it probably is” when this saying is not applicable.

    In the two and a half years that I have focused on this stock segment, I haven’t heard or seen any of these companies make a claim that was “too good to be true” (although I have heard and seen them make some claims that weren’t exactly true, just like other companies from around the world, including the U.S., do).  I have seen them grow at rates that only the best young companies from around the world grow at, et cetera.  It’s not “too good to be true” if it has been done and is being done by many other companies.  Young, successful companies do, sometimes, double, triple, quadruple, or more their revenues.  The idea behind this tactic is to get less-than-fully-knowledgeable investors to not buy or sell because, for instance, they don’t understand that, given the company’s specific circumstances, their margins can or should be that high (e.g., Harbin Electric [HRBN]) or that research from around the world performed over the course of decades supports the efficacy of the company’s products (e.g., Yongye International [YONG]).  Be wary; but be aware that Chinese companies, as well as companies from other parts of the world, sometimes make things better or do things better than companies in the U.S.

    (7) Presenting people with a (sometimes very long) string of misinformation.  If/when they finish debunking the misinformation, you can simply present them with more misinformation in response.  In so doing, you rarely, if ever, admit that any of your information was debunked.

    This can be done via a single very lengthy report or a string of smaller communications, like message board messages.  It takes relatively little effort to publish misinformation.  It can take a lot of effort to properly research and expertly word things.  The point here is to try to get you to say or think something like:  “It’s taking too much time and effort to make certain that this investment is safe enough, so I am simply going to pass on buying it.”  Or:  “Gee, I know that’s false and that’s false; but I am not certain about that.  I better just sell.”  A trick you can use to overcome this technique is this:  If, during the communication(s), the communicator displays a pattern whereby you know that they know, or very well should know, that multiple pieces of information they are presenting are false or misleading, view the remainder of what has been or will be communicated as not-necessary-to-view-or-hear.  To simplify, if someone lied, grossly exaggerated, or misrepresented two or three times, it’s not important for you to read their next point.  Even if a following or preceding point(s) does not seem to be false or misleading, assume that it is somehow.  At best it’s a truth being used to get you to believe a falsehood.  If you are going to spend any of your time on this stuff, spend it debunking and, ideally, making it clear that the author cannot be trusted.

    If/when any of the many short-side people who lie, exaggerate, or misrepresent respond to this article, I may simply ignore them.  It is only worth spending a limited amount of time responding to falsehood after falsehood after falsehood.  If, on the other hand, you are not one of these people, and you think I was significantly inaccurate with something I wrote above, you think that something I wrote above should be enhanced, or the like, please do point this out to me.

    Disclosures:  I am long YONG and HRBN.  Otherwise, I do not have a position regarding any of the companies mentioned in this article.



    Disclosure: I am long YONG, HRBN.
    Feb 08 3:26 PM | Link | 14 Comments
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