One of the favorite tactics of the more Gricean, scaremongery strategists in the early 2000s was a chart comparing the post-peak performance of the Nikkei and the S&P 500. There was never a lot of effort spent on the “why” of the seemingly inexplicable correlation between the two, the Japanese and US economies being so structurally different. Japan, with a giant, manufacturing-based trade surplus using the adapted technology of other nations (early 1990s patent reform remains a vastly underrated factor in the tech bubble) was faced by issues, the inbred keiretsu structure most prominently, that Teddy Roosevelt had taken care of for us (or so we thought). The persistence of the Nikkei/SPX correlation was, and is to a great extent, considered a statistical anomaly.
Investor psychology and the profit-driven (but not insidiously evil) influence of the finance industry are the two factors, which are demonstrably unchanged between the bull markets of Tokyo in the 80s and Silicon Valley in the 90s. The pattern is likely repeating itself in China.
My argument, roughly that China is following the same bull and bust pattern found throughout history, is dependent on distinguishing between the two types of market rallies. In the first, the Manic Type most widely associated with the Tulip Bubble craze, is an adolescent version where most professionals are aware that they are just dicking around, playing Greater Fool. Retail-related fads – Krispy Kreme, Crocs, Beanie Babies, Hoola Hoops and likely LULU sometime in the next ten quarters – feature prominently here. Everyone knows there a “best before” date on the whole thing, it’s just a matter of trading it and finding the exit before a fickle public gets bored.
The adult, Structural Economic version of the bull and bust cycle is a much more serious operation. It involves real, tangible change that dislocates economies across the entire planet for the richer: think steam engine, Internet, cotton gin, Ford’s assembly line, global trade (and the insurance business that made it financially feasible at the initial New World stages), China.
Examples of market reaction to the latter, major trends are remarkably consistent and numerous: well over 80% of Britain’s 19th century rail network was built after the collapse of rail stocks in 1846. The hundreds of American auto manufacturing companies active in the mid 1920s bankrupted their way to three. The same pattern will inevitably hold true for post-bubble technology networks in this century. In this light, using a more macro interpretation and a longer time arc, it is not difficult to see the Great Depression as the awkward adolescent stage of America’s technology-driven march to global economic dominance. The Asian Currency Crisis is a quicker version of the same process for the Asian Tigers. The pattern is evident in each case – a legit, undeniably powerful trend attracts far more investment than it can efficiently digest in a short period, inflated asset bubbles collapse, the actual sustainable trend takes hold.
In all likelihood China will eventually become the world’s largest economy but that’s not the point, at least for developed world investors. Economic changes to the degree being experienced in China have never occurred in history without a serious hiccough that makes every investor wet their pants for a considerable period. And currently, each passing month brings signs of structural stress in the Chinese growth engine – NPLs, inflation, social unrest, property price deflation, corruption, suspicious accounting – that make it increasingly difficult to argue that somehow China will be the first entity ever (and the largest by a wide margin) to transition smoothly from mammoth investment bubble to sustainable growth. This argument involves a New Paradigm.
Sell-side China bulls frequently imply that to be bearish on China-related investments is somehow analogous to long-term bearishness on the Chinese economy, an interesting rhetorical flourish designed to sustain investment in the short term. It would be far more interesting to hear the ways in which China will avoid the “investment bubble/collapse/then steady growth” process that economic history teaches us to expect. Indiscriminately shoveling money at legitimate trends until they break is just what we do. The odds, particularly in light of recent data, that we will have another chart to place alongside the 1980s Nikkei and 1990s S&P 500 appear much higher than an extrapolated straight line growth path into the Chinese century. I’ll wait for the hiccough and buy with both hands.