Pompano Frog's  Instablog

Pompano Frog
Send Message
Background: Former securities analyst and brokerage firm owner and Currently doing investment strategy consulting for institutional investors Undergraduate degree from Northwestern, Economics Taught Advanced Financial Markets Class at a University in Chicago In to Yoga.
  • CHINA READY FOR A 50% MOVE 21 comments
    Jun 25, 2013 5:13 PM | about stocks: FXI

    June 25, 2013

    S&P 500 1573.09

    FXI 31.70

    The Shanghai Composite closed last night at 1959.51. That is down 14.8% for the month of June, 2013. That is a large drop. Since 1991 there have been only three times in a 12 month period where you have had a drop of that magnitude in a single month.

    The Bank of China fully understands that large stock market movements are the transmission mechanism of financial liquidity and monetary policy to the real economy. They will do whatever needs to be done to move this market higher.

    Chart forSSE Composite Index (000001.SS)These are the previous three periods of large one month drops:

    1993.05 -31.2 935.48

    1994.07 -28.8 333.92

    2008.10 -24.6 1728.79

    2013.06 -14.8 1959.51

    To outperform the market indexes it is necessary to anticipate the future moves of the global asset allocators. What are these institutions using as a basis for making radical changes in sector and country allocations?

    Let me suggest that they are using factors that fall into two categories consisting of valuation factors and monetary factors. The main etf for the Chinese market, the "ishares FTSE China 25 Index Fund" is trading at 9x trailing earnings and 2.2x cash flow. This is in an economy with a 7% long term growth forecast.

    Chart foriShares FTSE China 25 Index Fund (NYSEARCA:<a href='http://seekingalpha.com/symbol/FXI' title='iShares China Large-Cap ETF'>FXI</a>)

    On the second front, monetary factors, the Bank of China is going to respond to the market panic with exactly the same massive liquidity expansion as they used in 2008.

    2008 September 2293.78

    2008 October 1738.79 Panic

    2008 November 1871.16

    2008 December 1820.81

    2009 January 1990.66

    2009 February 2082.85

    2009 March 2373.21

    2009 April 2477.57

    2009 May 2632.93

    2009 June 2959.36

    2009 July 3412.06

    On the first page of the Wall Street Journal is the headline "China's "Shadow Banks" Fan Debt-Bubble Fears ." The Wall Street Journal hates China. How do you explain to your followers of the "small business man made America great with free markets" to the reality of 2.5% long term economic growth when a communist oligarchy is able to churn out 7%.

    The important thing to remember when you are talking about China you are talking about a country with a household savings rate which was 16% in 1990 and was 30% in 2010. You have massive amounts of new domestic capital flooding the investment system every year. A country expanding at 7% needs massive amounts of capital to maintain the investment rate to support that growth rate.

    I highly recommend a 2008 book by the Korean economist Ha-Joon Chang, "Bad Samaritans, The Myth of Free Trade and the Secret History of Capitalism." This is a solid, well documented, easy to read, presentation of the case for state managed capitalism and explains clearly the Asian economic model. The book sells for $10 in paperback or on kindle.

    The Bank of China is going to be under enormous pressure from their political bosses to do something. They will err on the side of making sure they are not sent for reeducation. To the Chinese Central Committee capitalism is a tool to provide resources for the party. Those resources create social stability and an expansion of military power.

    FXI (China ishares ETF) is the investment idea for the next six months.

    Disclosure: I am long FXI.

    Stocks: FXI
Back To Pompano Frog's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (21)
Track new comments
  • Sam Liu
    , contributor
    Comments (3711) | Send Message
     
    WIKIPEDIA
    The SSE Composite Index (Chinese: 上海证券交易所综合股价指, 简称上证综指) is an index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange.

     

    The base day for SSE Composite Index is December 19, 1990, and the base period is the total market capitalization of all stocks of that day. The Base Value is 100. The index was launched on July 15, 1991.
    25 Jun 2013, 10:20 PM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Sam..

     

    Thanks for your comment. My basic premise here is that both valuation and monetary factors are aligned as they were in the U.S. in March, 2009.

     

    My Jan, 2014 normalized earnings estimate for the Shanghai Composite is $229 and at 17x those earnings the Shanghai will trade at 3900. I expect the U.S. market in Jan, 2014 to be also trading at 17x earnings.
    26 Jun 2013, 08:03 AM Reply Like
  • KilgoreTrout
    , contributor
    Comments (54) | Send Message
     
    Hi Pompano,

     

    I've followed your comments for a while now, and find them incredibly helpful.

     

    One question I have for you is on forecasting multiple expansion. Currently the S&P is trading at about 14x forward expected earnings, and the historical average is approximately 15x. So I was expecting it to revert to the mean and hit 15x sometime next year, but I don't really have any basis for this. I understand that P/Es are based on expected growth, but I'm not quite sure how to go about forecasting this. If you could explain your thoughts on why we would get to 17x so quickly would be much appreciated.

     

    Thanks
    26 Jun 2013, 08:29 AM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Kilgore..

     

    My normalized p/e, 1/3 of the data points over the last 50 years, is 16x to 18x. Thus, I assume that our financial structure in the U.S. will easily support that level of valuation.

     

    Why I think it could move quickly up to 17x is because of the M1 growth rate, the positive yield curve and the negative real interest rate. Once these factors are in place the stock market follows.

     

    Take a look back at the historical highs and lows over the last 50 years rather than try to research the factors that give you the best fit over the entire period. The same applies to market segments and industries.

     

    I just try to get the direction right and be in front of the large institutional players. I believe 90% of large investors believe stock markets reflect the real economy and I believe that is a limited viewpoint that can really effect your stock market performance.
    26 Jun 2013, 08:40 AM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Kilgore..

     

    I wanted to add one more thing I thought might be helpful. I saw from your previous comments you use regression. So do I. But, I think regression is very limited because it does not focus on the extremes. I think if you use "data sort" you will have better insight.

     

    Thus, I always have a column next to the historical data I am reviewing which is for example "S&P 500 18 months forward." Then when I sort I can see if high M1 12m% is associated with big moves in the S&P or whatever financial variable I am studying.
    26 Jun 2013, 08:46 AM Reply Like
  • KilgoreTrout
    , contributor
    Comments (54) | Send Message
     
    Thanks for the advice.
    26 Jun 2013, 09:49 AM Reply Like
  • AllStreets
    , contributor
    Comments (1464) | Send Message
     
    I saw your sage comment re "Retirees Please Don't Index, You Deserve Better Than Average" and got interested in FCA as a result. Now I see your entry here regarding FXI. Have you compared FCA and FXI, and have an opinion about which has better prospects? I'm guessing you prefer FCA based on the equal weight approach and your more recent comments.

     

    I looked up both on dividend.com and found FCA with big 83% increase in dividends in 2013 vs 2012, but quarterly dividend all over the place since 2012.06, and down to almost nothing in 2013.12, and apparently without any dividend for 2014.03, and none yet listed as upcoming for 2014.06. Is that an artifact of the equal weight ETF structure, or does that reflect a problem with earnings of all the underlying stocks?

     

    I note that FXI is cap weighted and is comprised of 56% financials, mostly banks, which I assume are exposed to the widely expected problem of failing real estate loans.

     

    You indicate a great valuation gap between US stocks and the FCA stocks which is very appealing, but not if earnings are tanking and thereby will correct the valuation going forward. You said you pick stocks from the list of holding of FCA. Do you avoid the banks?

     

    What worries me about mainland Chinese stocks are the very high marginal dependence on either government investment policies (I read somewhere that's some 60% of the Chinese GDP) or exports to the stagnant economies of Europe and the US. On the other hand, the chart of FXI from 2007 to now looks a lot like the chart of the Dow from 1987 to 1992.
    1 Jun 2014, 09:18 AM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Allstreets...

     

    In my research I find not one piece of evidence to support widespread real estate loan failure now or in the future.

     

    I find the source of these facts are, as I have said, political scientists, historians and writers who are appalled by the economic success of a totalitarian regime.

     

    With another significant group applying the U.S. real estate market model to what is a totally different structure in China.

     

    Since they don't mention any of these differences in structure I have to assume that they are not aware of their impact.

     

    And then of course, most of these writers on SA know little about investing. You just need to go back a few years, if available, to see if they have any insight.

     

    Private investment as a % of GDP has been growing almost every year. I suspect that the trend has been a product of government planning. Their model of growth has been no different than Japan after the war or Korea.

     

    China is currently roughly 20% of U.S. per capita GDP.

     

    This is roughly Japan in the late 1950's. I should recheck my spreadsheet on that. Maybe early 1960's. Think of the upside.

     

    Think of the risks and rewards from holding a pension account for China equities vs. U.S. indexes.

     

    The Chinese authorities control real estate prices. They saw no reason to allow developers to reap the gains from the increases in China GDP so they have set those prices at a level competitive with other global competitors.

     

    I estimate that while developers make 15% profit margins, another 40% of the purchase price is a hidden consumption tax on the wealthy. This money is what is being used to fund infrastructure investment.

     

    This reminds me of the Sharon autobiography "Warrior." Sharon has his army halted in the middle of battle because headquarters is explaining to him that he is surrounded. He has to fly back, and pick up a general, to take him to the front to show him that it is he who is doing the surrounding.
    1 Jun 2014, 11:49 AM Reply Like
  • KilgoreTrout
    , contributor
    Comments (54) | Send Message
     
    Hi Pompano,

     

    Just curious if you're still optimistic about FCA? With the continued pressure on the fund, any idea at what point do they begin considering liquidation, and then you can't afford to wait for the turnaround?

     

    Thanks
    11 Feb, 10:06 AM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Kilgore..

     

    First Trust owns a group of these AlphaDex Funds. I would think they would liquidate China dead last. Anyone who would be in the ETF business would understand the enormous potential of China for future inflows.

     

    The Chinese economy is incredibly large. How long can global money managers hold out in adding China to their portfolios? The price discrepancies between ^HSCE (the Hang Seng Enterprise Index) and other global markets are enormous.

     

    Since March, 2014 value investing has been in a huge bear market. China has been weak, oil has been weak, and the Euro and Yen have been weak.

     

    All of these patterns are cyclical. I am just early. Momentum has been outperforming value. That is not the long term case.

     

    Let me suggest that my fundamental analysis of China has been correct.

     

    If I had a friend who was unrestricted by prejudice against China and/or did not have regulatory restrictions I would have 60% of the value in FCA.

     

    Future price movement is a function of valuation and monetary/liquidity factors. China is the play for the next cycle.
    15 Mar, 09:01 AM Reply Like
  • KilgoreTrout
    , contributor
    Comments (54) | Send Message
     
    Hi Pompano,

     

    Thanks for reply.

     

    I would certainly agree with you on China.

     

    I was just concerned about whether such a small ETF could sustain prolonged weakness. As I have no idea at what point an ETF gets shut down due to lack of AUM. And whether this could potentially force liquidation at an inopportune time? Although I suppose you could always just reallocate to another China fund if that were to occur.
    15 Mar, 01:12 PM Reply Like
  • Quin103
    , contributor
    Comments (206) | Send Message
     
    Chin retail sales are down 50% from 2008, still growing10% a year though. But grew 20% a year a few years ago. This is a structural global slowdown, we are heading to the baseline of non-credit based growth potential, a first in decades. I think China can fall alot more before value reasserts itself
    15 Mar, 01:36 PM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Quin..

     

    Equity prices and real estate prices distort over the short term monetary behavior. The fall in equity prices from the 2009.07 Shanghai top has removed an enormous amount of purchasing power from the Chinese economy.

     

    Because of China's huge domestic savings rate they have unlimited upside to expand stimulus.

     

    There are no capital outflows from China. Every historian and English professor wants to tell their gullible students that China is a failure. It is the U.S. that has lost its economic global dominance.

     

    But, in the end the most important point is price. The decision makers see the past also and they react to that past by putting in place policies that create the future. China is cheap. FCA is very cheap.
    15 Mar, 02:38 PM Reply Like
  • Shaduc
    , contributor
    Comments (2948) | Send Message
     
    "Chin retail sales are down 50% from 2008"

     

    CAN you cite a source to support your claim.
    15 Mar, 06:53 PM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Shaduc..

     

    I assume you are asking about China capital flows.

     

    Go to the BIS website. There are several papers analyzing global capital flows.

     

    If you are referring to the effect financial markets have on the real economy I refer you to Bernanke research entitled "the Financial Markets Model."
    16 Mar, 08:10 AM Reply Like
  • Shaduc
    , contributor
    Comments (2948) | Send Message
     
    PF:

     

    I asked someone else, but Quin made an outrageous claim that retail sales declined 50%. Inflation persists.And then he says retail sales grow 10%/year.

     

    What is BIS?

     

    Incidentally, I noticed my name as the 1st comment 2.5 years ago ...
    16 Mar, 08:25 AM Reply Like
  • Quin103
    , contributor
    Comments (206) | Send Message
     
    shaduc, take a look at the retail sales chart in this article. 10% sounds big, but its nothing like the 20% in 2008.
    http://bit.ly/1Rl1zWN

     

    theres a persistent slowdown globally, and it doesnt look like the 7-year length cyclical boom/busts cycles were accustomed too, instead it looks like a giant descending slope into nothingness, after a giant uptrending slope for decades. The cycle im talking about is a huge one of many decades, and that is worrying.
    16 Mar, 12:44 PM Reply Like
  • Shaduc
    , contributor
    Comments (2948) | Send Message
     
    20%, not 50%?
    Typo?
    16 Mar, 05:53 PM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Quinn..

     

    10% is huge..

     

    The 20% in 2008 was due to the stock market bubble.

     

    Retail sales expanded in an unforcasted way in the fall of 2009 following our stock market rally.

     

    It was the 20% that was the outlier.
    17 Mar, 09:36 AM Reply Like
  • Pompano Frog
    , contributor
    Comments (1902) | Send Message
     
    Author’s reply » Shaduc..

     

    BIS is the Bank for International Settlements in Basel Switzerland. They are the bank that settles transactions between all of the central banks. They keep the statistics and make the regulatory framework for all of the central banks.

     

    Foreign central banks and international economic organizations are a great tool to keeping up with the cutting edge of the research that in the future will become policy.

     

    You just need to read the introduction and the conclusion.
    17 Mar, 09:39 AM Reply Like
  • Quin103
    , contributor
    Comments (206) | Send Message
     
    well 10% is down 50% from 20%? any case its just semantics of how you define percentages, but I think you get my point
    17 Mar, 10:12 AM Reply Like
Full index of posts »
Latest Followers

Latest Comments


Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.