As recently as September of last year Deutsche Bank had forecast the ASX would hit 6,000 points. Provided the economy avoided recession, they said, the outlook for 2016 was positive.
We’re a little under two weeks into the New Year and there’s no immediate threat of recession as yet. Which is understandable enough. For every bit of doom and gloom news, there’s another talking about how (unsettlingly) normal things are. Business investment is down, but unemployment is steady. Wages growth is static, but property values are holding up. Well, you get the picture.
Either way, the earliest the economy could downturn is mid-year. Recessions require two straight quarters of declining GDP growth. And after positive fourth quarter figures last year, we’d need to wait at least two quarters before we test another recession again.
Yet it’s become clear that 6,000 points could be out of reach with or without a recession.
The ASX 200 has just come off its worst start to the year ever. It hit a two and a half year low of 4,880 points on Monday. And despite a late flurry to finish the day, it closed on an underwhelming 4,932. As of early Tuesday trade, the market was up slightly at 4,980 points.
So how do we account for the worst start on the ASX to a year ever?
As always, the finger pointing is directed squarely at China. Everyone is worried about China. If there’s a problem in the world, it probably has something to do with China. Forget the fact that Australian pollies were too small minded to rebalance the economy when they had a chance. Forget that the global debt stems from the sea of credit the West dreamed up out of thin air. Forget all that. It’s all China’s fault. If we can’t fault China for all our miseries, who can we blame?
We can’t blame emotionally driven markets that react to any signal with either glee or panic, with no middle ground. The same markets where short sightedness passes for a strategic plan.
Hoping for change in the way markets operate is wishful thinking on my part. I don’t for a second believe investors will ever stop acting out on impulses. Regardless, you do wonder why investors don’t use more perspective when it comes to China.
If you know the Chinese economy is having growing pains, why react to every little spasm? Why pour money into, and out of, companies whose share prices fall or rise on the back of China’s economy?
You either see China for what it is, or you imagine it to be something that it isn’t. If you’re confident that China will find its feet eventually, you’d keep some perspective. If, on the other hand, you’re not confident, then what exactly is your end game? Investing in such stocks on the ASX, a victim of the mood swings from a bi-polar Chinese economy, looks unwise. And that’s putting it mildly.
Of course, the answer to why people invest in stocks is obvious. They do it to make money. And you can always make money, even in a bear market. But for other investors, who aren’t engaging in speculative behaviour, a bit of perspective wouldn’t go astray.
And yet…nothing will change. Investors will continue to look at China and be surprised when things turn for the worse. They’ll regain confidence in China again at some point, and lose it just as quickly. They’ll look on at the currency devaluations with anxiety. They’ll question the direction of China’s housing market and what it means for its economy. And they’ll remain traumatised by China’s wild stock market swings.
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Last week, Chinese stocks markets went offline after plunging more than 7; not once, but twice. And yet Aussie investors still invest in companies that have wedded themselves to China’s success.
In the case of Australia’s mining stocks, investors are in it for the dividends. BHP Billiton [ASX:BHP] pays generous yields, among the highest on the ASX. Yesterday, BHP’s stock price fell to an 11 year low, to $15.55 a share. Some investors have decided enough is enough. Others will hang in there because BHP pays out solid cash returns.
Rio Tinto [ASX:RIO] dropped as well. It slumped to a seven year low, trading at $40.50 a share.
Problem is, stock markets work a little like pyramids. Any sector sitting at the top, like mining, which yields such influence over an economy cascades all the way down when things go wrong. Which makes in any company or sector an inherent risk.
None of this should be new to anyone. If you’re going to deal with stocks, which increasingly move on Chinese data, prepare yourself for anything.
What China’s economic transition means for the ASX
Knowing that China will continue to drive success on the ASX, how long will it last? How much longer do markets have to put up with China’s ongoing transition?
A decade, and that’s providing things go to script. This projection isn’t something that’s been pulled out of thin air. Researchers at Nielsen have analysed China’s situation in great detail. What they found should interest every investor on the ASX that’s waiting for an end to China’s transition. Louise Keely, a key figure at Nielsen, notes (emphasis mine):
‘Given the long boom in spending, it’s easy to overlook the fact that consumption as a share of GDP has actually been falling in China for six decades. In 1952, three years after the Communist Revolution, it stood at 76%. By 2011, it had fallen to 28%.
‘A reversal of this trend could catapult consumer spending upward. But our research into the transitions made by 167 countries in the last 60 years shows just how hard it will be to nudge China’s super-tanker of an economy in a different direction. Indeed, while consumption’s share of GDP will very soon stop falling, our research suggests it is unlikely to start to rise significantly for another decade.
‘China finds itself in a particularly tricky starting position. Not only is the decline in Chinese consumption relative to GDP the longest on record, it’s also unique in that both the relevant drivers of consumption’s share of GDP have fallen—household income as a share of GDP, and the proportion of that income that householders choose to spend rather that save. Those countries that successfully managed to reverse a decline in consumption’s share of GDP only had one of these factors to tackle.
‘To be clear, consumer spending will continue to grow as the economy grow, whether or not the government takes measures to boost consumption. Modest growth in consumer spending of just 5% a year would see it rise by a total of 330 trillion yuan over the course of the next decade — the equivalent of 60%, even if consumption’s share of GDP doesn’t budget.
‘On the other hand, if China manages to change course and follow the route taken by most countries transitioning away from investment and export-led growth, consumer spending could be worth as much as 420 trillion yuan by 2025, a rise of 126%. This would lead to represent a rise in consumption to 46% of GDP, a proportion typical after a transition in countries in which consumption’s share of GDP rises after a period of decline.’
China’s economic transition, away from manufacturing and exports, began three years ago. Such a seismic shift isn’t easy for any economy, let alone the world’s second biggest economy. But, if Nielsen forecasts are to correct, it could take 10 years for China to fully rebalance its economy. Which suggests lower growth will mire China’s economy for a very long time.
For the local share market, it could mean another decade of turmoil and market instability. If you squint hard enough, you can just about make out a 6,000 point ASX on the horizon.
Junior Analyst, The Daily Reckoning
PS: Both Chinese and Aussie markets have made a horror start to the New Year. Looking ahead to the rest of 2016, they’re not likely to get any respite. The Daily Reckoning’s Vern Gowdie believes we’re heading towards a much larger crash.
Vern is the award-winning Founder of the Gowdie Letter and Gowdie Family Wealth advisory services. He’s ranked as one of Australia’s Top 50 financial planners.
Vern wants to help you avoid this coming wealth destruction. His special report, ‘Five Fatal Stocks You Must Sell Now’, will show you how. In it, Vern shows you which five blue chip Aussie companies could destroy your portfolio…you almost certainly own one of them. To find out how to download the report, click here.