Note to the market: The Eurozone crisis hasn’t gone anywhere. The US and Iran are facing off in the Straits of Hormuz, the world’s most important oil supply route. And China’s economic slowdown has only just got underway.
The response? A blistering two-day rally to kick off the year. Welcome to the January Effect! According to Wikipedia…
‘[T]he January effect is a calendar-related anomaly in the financial market where financial security prices increase in the month of January. This creates an opportunity for investors to buy stock for lower prices before January and sell them after their value increases.’
In the Washington Post, finance professor Stephen Ciccone wrote…
‘In a recent paper in the Journal of Behavioral Finance, I connected January optimism to an overall rise in stock prices. The results were clear: Whether in boom times or in recession, bears hibernate in January, and positive-thinking bulls run free.’
It seems gorging over the Christmas break – and hanging out with friends and family – makes us a bit sentimental. We become optimistic about life and resolve to do things better in the New Year.
We then blindly project that optimism into a wider sphere. ‘Perhaps the Eurozone will sort itself out.’ ‘China’s central planners will be able to engineer a soft landing.’ ‘I should move from cash into the market.’
The New Year forecasts from the experts reinforce these positive thoughts. ‘The market looks cheap.’ ‘The first half will be tough but expect a pick-up in the second half’. Don’t think, just buy.
BHP chief Marius Kloppers certainly looks like he filled up on trifle on Christmas day. Today’s Australian carries a long story on Australia’s ongoing resources boom. It quotes Kloppers as saying ‘China will do anything to get that economy to grow.’
Ahhh…such is the faith in a centrally planned economy that even the head of the largest mining house in the world is convinced not much can go wrong.
Our guess is China’s growth in 2012 and beyond will surprise on the downside. You don’t recover from an epic credit boom in six months. This is far from a ‘soft patch’. Like the US in 2006/07, China’s economy is heading into a post-bubble period. How it will play out is hard to know. But don’t expect more of the same.
Keep in mind China is still in the early stages of its downturn. Despite an apparent ‘tight’ monetary policy, statistics from the People’s Bank of China show a 15.6 per cent jump in bank lending (in the year to November). That translates into a US$1.4 trillion increase in bank credit. And that’s only official data! Add in all the shadow lending designed to get around official rules and real lending is much higher.
Regardless, the consensus is China has held monetary settings ‘tight’ in the latter half of last year.
Bank lending growth may be robust, but it’s producing poor economic growth. The performance of the Shanghai stock market attests to this fact. After responding well to stimulus in 2009, the Shanghai Composite Index spent 2010 and 2011 in decline. The booming property market could not spread its gains to the stock market.
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From a short-term view, the quality of China’s economic growth doesn’t really matter for Australia. Strong economic growth translates into strong demand for our resources. As long as mining companies produce decent returns on invested capital delivering the resources to China, it should benefit Australia.
But there’s a long-term problem with that line of thinking.. But it’s one China’s other major client, Rio Tinto, doesn’t appear too concerned about. Rio boss, Tom Albanese clearly overindulged at Christmas as well. The Australian quoted him as saying: ‘If you are going to be in a sector, mining is as good as any and certainly mining in Australia, with its proximity to Asia, is the place to be.’
Now there’s nothing wrong with that statement. It’s pretty bland…and soothing. But it comes from a bloke who in May 2007 paid US$38 billion to purchase Canadian aluminium producer Alcan. Oh – and he financed the purchase with debt.
Just as the wheels were clearly falling off the US housing market and credit bubble, no one at Rio thought it was a dumb idea to borrow around US$40 billion to buy aluminium assets. It was a dumb idea. It ended up smashing the share price and nearly bankrupted Rio Tinto… a139-year-old company.
Sorry for having a memory. Albanese and the Rio board wouldn’t know a credit bubble if it poked them in the eye.
They – and most miners – probably can’t see Australia’s commodity boom is the result of China’s credit boom. According to the Australian, there is $232 billion worth of projects at an advanced stage of development with a further $224 billion in the planning stage.
That’s impressive. In the short term it will bestow riches on the suppliers and contractors involved in these projects. But over the long term you have to ask – will the demand for resources that follows generate a good enough return on capital investment?
There’s an awful lot of capital investment going on. For the $232 billion in development underway right now, a 20 per cent return would equate to $46 billion in operational earnings. That’s a lot of money.
While the analysis is simplistic it also shows you how hard a task some companies face in justifying such large investments. Especially when predicated on a Chinese mega-boom that peaked in 2011. We’ll call it the ‘China Effect.’
for The Daily Reckoning Australia