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China Likely to Take Foot off Throat of Economy

China Can Take Foot Off the Throat of the Economy

I haven't written much content about the market's recent schizophrenic personality.

I do know that every time I've seen the VIX (Volatility Index) trades over 40 for any length of time, it was always a buying opportunity. It's simply a matter of turning off CNBC and thinking clearly.

I don't believe people in the US or China will spend less at WalMart or buy fewer new iPads this weekend because the French bank Societe Generale might have more problems than has been disclosed. This coming week all the big wigs will drag their butts into the office from their extended vacations on the French Riviera and tackle the perceived problem. I know this International banking stuff is all intertwined, and a default from a large French bank might have some effect on American Depositors- but the market is having an overblown manic moment over it.

No doubt there is some sort of global slow down in the cards as Europe sorts out its banking issues circa the US 2008, and the market continues to be exasperated with Washington's failure to deal with our even expanding deficit.

In a perverse way, the perception of a global slow down will help China equities behave far better.

Here's a chart comparing the action of the S&P 500 to its China equivalent: The Shanghai A shares:

On this chart, the relative performance of the S&P 500 (black line) is compared to the performance of the Shanghai A shares (red line) going back to early June.

The two mirror each other rather closely until this past week. The Shanghai A shares have corrected, but not nearly as insanely as the S&P 500.

Of late the S&P fell 8%, while the Shanghai only fell 6% and rebounded far more easily with a lot less volatility.

I believe there's three key factors pushing money towards the Shanghai A's:

  • The Chinese Yuan hit a 17 year high against the dollar this past week, making the goods China imports cheaper.
  • A banking crises in Europe would not have the same domino effect on financial institutions in China- the exposure is much lower.
  • A global slow down will help the Chinese economy's problem with inflation.

#3 is the Big Kahuna for China. After 5 interest rate increases and the implementation of a number of other initiatives to slow growth in China, inflation continued to be strong in July.

However, with the Yuan firming (making imported food and oil cheaper), and the spectre of a global slow down, it would appear inflation in China can be expected to moderate significantly due to slowing demand for manufactured goods.

8 of 10 economists polled this past week believe China will not raise interest rates again this year. Two weeks ago 8 of 10 economists were forecasting another interest increase was just around the corner. China can now take its foot off the throat of its economy, and stop trying to choke a slow down.

Inflation and governmental tightening regimes are the enemy of equity appreciation. When the macro picture screams slow the economy down, equities simply do not trade well.

Once the smoke clears in Europe, and the volatility decreases, equity money will start to flow back towards growth, and once again the only place to find it will be emerging markets, with China still having the pole position and the greatest upside.

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In the past 8 trading days, the #1 recommedation is up 27%.

 

 

Warmest Regards,

Larry Isen