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The Great Empty Buildings of China

It’s the start of the month, which means the market focusses on global manufacturing data and, here in Australia, the Reserve Bank’s decision on interest rates. It doesn’t get much more exciting than that, dear reader.

So, what’s the manufacturing scorecard? Well, JP Morgan’s global manufacturing index came in at 50.6, unchanged from the month before. A reading above 50 indicates expansion, so the manufacturing sector is keeping its head above water. But only just.

The chart below shows that after rebounding strongly in 2009/10, global manufacturing activity is in the doldrums. So despite years of coordinated central bank debt monetisation efforts and large government deficits to stimulate demand, manufacturing continues to struggle.  

But that shouldn’t really come as a surprise. It’s well known by now that QE benefits asset markets rather than the real economy. Money printing for the benefit of the hedge fund class is hardly going to improve the prospects of the world’s manufacturers.

Still, it didn’t stop the market reacting well to US manufacturing data overnight…and ignoring the continued weakness in China’s manufacturing sector. Which was a turnaround from yesterday when the Australian market sank nearly 2% on fears over a hard landing for China’s Ponzi economy.

But why try to make sense of these day-to-day moves? What impresses one market depresses another. The question we want to know the answer to is, where is all this heading? Are market’s consolidating before going on to new highs, or in the process of topping out, with much greater falls set to come?

We think it’s the latter and have been warning our subscribers for a while about a potential market crash. The first leg of the crash has already played out. Now we’re waiting for next one. Timing is not our forte, so we asked Slipstream Trader Murray Dawes for his thoughts on the structure of the S&P500:

‘The S+P 500 is looking very interesting technically at the moment. We have had the first indications that the long term momentum is shifting to the downside, but we haven’t yet had confirmation of a change in the long term trend to down. 

‘This phase of the market sees volatility picking up as large forces interact. Buyers are still confident while the long term trend remains up, but profit taking and an increase in short interest sees larger swings to the downside.

‘It is still uncertain who will win the battle but there are a few technical indicators saying that
the bears will get the upper hand before long, which could lead to a sharp move in the S+P 500 down to c. 1500, a 7% fall from here. 

‘The most interesting thing that I have my eye on is the 2007 high of 1576. A false break of that level will look like a large double top that could spell the end of the four year bull market.

‘The weekly MACD has now rolled over to the downside and over the past four years it has
been a great warning signal that a correction in prices was close by.

‘But the fact is the 10 week moving average is still above the 35 week moving average, which means the S+P 500 is still in long term uptrend. So we should expect to see good buying support at key levels.

‘The next major level of support below here is at the 200 day moving average (1510).

‘My prediction from here is that the current short squeeze will end within the next week and then we will see a sell-off in the market towards the 200 day moving average. My gut feel is that we will end up seeing much lower prices than that if the double top that I spoke about above comes to fruition, but for now a target to the 200 day moving average while we remain in long term uptrend is the more prudent goal technically.’

If you want to learn how to protect yourself from a falling market, click here.     

The source of our bearishness comes down to China. We think it reached an inflexion point in its historic credit bubble last month and you’ll see more evidence of that in the months to come. With every weak data release there is a clamour of opinion stating that China should provide some stimulus to boost demand. But as we’ve argued before, we don’t think this is going to happen. The economic rebalance is underway, and China’s leaders will simply try to stop it from getting out of hand, rather than reverse it.

China’s leadership recently made comments that people should judge them on more than just the economic growth numbers, clear evidence that they are willing to let GDP drop below their target levels without getting into a panic. A rebalancing Chinese economy will result in much slower GDP growth, and it seems China’s leaders now recognise this.

With a bursting credit bubble come signs of excess capacity, and Bloomberg reports that ‘Chinese landlords are forgoing rent and paying to outfit stores for mass-market fashion brands including Zara and H&M, a bid to blunt the impact of a boom in shopping-mall construction that threatens to push up vacancies.’

According to the article, around half of the 32 million square metres of shopping malls under construction around the world today are in China. That’s a lot of supply coming on line, which will need a lot of shops and customers to be economic.

And therein lies China’s problem. Because economic planners have directed the building boom, much of the infrastructure exists to satisfy a demand that isn’t really there. When something is built, whether it’s a shopping mall or an airport or an apartment block, it needs to generate a return to service the debt that funded it and allow for the eventual repayment of the debt.

In China this is not happening. Developers obtain money for projects by directive rather than by market forces rewarding a good idea. This leads to oversupply and ‘misallocated resources’. From Bloomberg:

‘Mall space in China’s four major cities will grow about 40 percent by the end of 2015, while in 16 smaller cities it will double in the period, according to Steven McCord, China retail research director at property brokerage Jones Lang LaSalle Inc. (JLL)

‘Developers of some new malls may struggle to reach even 70 percent occupancy, forcing delays in opening, said Michael Zhang, executive director and co-founder of Beijing-based RET Property Consultancy.’

China will eventually grow into all this infrastructure. But it will take time. And as they say, time is money…

Which is possibly why Aussie businesses don’t like what they see ahead. Dun and Bradstreet’s July release of business expectations make for ugly reading as business expectations for employment, capital expenditure and sales in the months ahead all hit their post-GFC lows.

Against this backdrop, what should you expect from the RBA today? We’ll hazard a guess that they will do nothing. But in the next few months we reckon they will continue easing to new record lows as the China slowdown and the end of the mining boom bite even deeper.

Greg Canavan+
for The Daily Reckoning Australia

From the archives…

The Tentacles of the US economy
01-07-2013 Greg Canavan

Bernanke Fumbles, the Market Tumbles, The Daily Reckoning Grumbles
29-06-2013 Nick Hubble

How The Power of Tweets Saved Tesla Motors
28-06-2013 Sam Volkering

The Best Way to Invest in a Volatile Market
27-06-2013 Kris Sayce

Is Technology The Most Exciting Industry in the World?
26-06-2013 Callum Newman

2 Comments

  1. BP says:

    Jeez, FINALLY some acknowledgement that the Chinese will, albeit forcibly, move their rural populations into these ‘ghost cities’… .

    Do you figure the US will be able to exercise the same kind of totalitarian control in moving their populations into far-flung, deserted outlying stucco residential communities?

    Gotta laugh when I read these ‘bubble parables’. DR has helped inflate the greatest bubble of them all, in over half-a-decade… but still has the cheek to call the kettle black… . :D

  2. JS says:

    This issue could be related to China’s demography with the country’s low birthrate (1.3) and aging population combined with the fact that China’s population will soon begin to decline.

    With population growth halting and with the following era of population decline begining soon, the Chinese will find it increasingly difficult to fill theses ‘ghost cities’.

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