China: Choosing More Debt, More Unemployment, Or Transfers | Michael Pettis

From Michael Pettis:

I have often written in this blog and elsewhere about the three policy choices Beijing faces as it tries to manage through the adjustment process. My argument is that subject to two very plausible assumptions, every economic policy Beijing implements ultimately can be abstracted to one choice among three options. These two assumptions are:

  1. China has overinvested in infrastructure and manufacturing capacity to such an extent that in the aggregate the cost of additional public sector investment exceeds the present value of future increases in productivity generated by the investment. China’s public-sector investment, in other words, is value destroying, and because it is funded by debt, additional investment causes China’s real debt servicing costs to rise faster than its real debt servicing capacity.
  2. China’s long-term sustainable growth rate is substantially below the economy’s current GDP growth target, and so the economy is only able to meet the growth target by increasing its debt burden.

…..any policy Beijing chooses must involve, usually implicitly, some combination of three outcomes. In every case, in other words, we will see as a consequence of the policy one or more of the following:

  • Higher unemployment, the limit of which is largely a political issue involving social instability, with the added wrinkle that certain types of unemployment are likely to be perceived as more politically costly than others – e.g. because returning to family farms acts as a kind of safety valve, even though a significant fall in living standards, unemployment among migrant workers is likely to be less costly, or because university graduates are presumably more communicative and have higher expectations, their unemployment might be more costly.
  • Higher debt, by which I really mean a higher debt burden, or an increase in debt relative to debt-servicing capacity, and this can rise until credit growth can no longer be forced up to the point where it can be used to roll over existing debt with enough margin fully to fund as much new economic activity that Beijing targets.
  • Higher wealth transfers, in which governments – and because the Xi administration is seeking to centralize power this is most likely to involve local governments rather than central government entities – must liquidate assets and use the proceeds directly or indirectly either to increase household wealth or to pay down debt, with the main constraint on Beijing’s ability to direct this process likely to be the tremendous political opposition of the so-called “vested interests”, for whom government control of these assets is an important source of power, patronage, and wealth.

The trade-offs between a higher debt burden, higher unemployment and greater wealth transfers to the household sector may come into sharper relief in 2016 because although unemployment still seems to be fairly low, in spite of much lower growth in the past three years, there is now reason to worry that any additional reduction in growth may begin to show up in the unemployment numbers…..

Centrally-planned economies inevitably get weighed down by cronyism and inefficiencies. Economist Thomas Sowell describes how he used to be a Marxist but working for the federal government cured him of the notion that centralized government could successfully manage anything, let alone the entire economy.

Source: China: Choosing More Debt, More Unemployment, Or Transfers | Michael Pettis’ CHINA FINANCIAL MARKETS

Thinking Historically: A Guide for Strategy and Statecraft

From Francis J. Gavin, Frank Stanton Professor in Nuclear Security Policy Studies at MIT and author of Nuclear Statecraft: History and Strategy in America’s Atomic Age:

It is not always clear in real-time what matters most, though a historical sensibility can sensitize us to look for real-world consequences in unusual places. Will the recent U.S. presidential election seem like the key issue we faced 30 or 40 years from now, when perhaps some deeper, more fundamental shifts (the climate or demographics, for example) or a completely unexpected event shapes the realities of that future world? We don’t know, but it is worth considering.

Relatedly, history conditions decision-makers to understand that policy decisions made in world capitals are often far less important in shaping what matters in the world that other, often less visible historical forces. Culture, technology, demographics, and geography, for example — all are critical forces that are less pliable to policy than we often think.

My favorite examples are three events that took place within a very short period of time: the sale of the early Apple personal computer, the release of Star Wars — the highest grossing motion picture of all time, and the famous 1976 “judgment of Paris” in which previously unknown wines from Napa Valley bested established French wines in a blind taste test. In other words, policymakers in Washington in the mid-1970s who were pouring over economic data, looking at crime statistics and urban crisis, witnessing political chaos abroad, and fearing a Soviet military behemoth that appeared to be winning the arms race had little reason to be optimistic about the future.

But the future was being made elsewhere and in different ways than policymakers understood in places like California, where deep and often obscure historical forces were working to transform the U.S. economy, society, technological base, and culture in ways that would have profound effects on American power and world history.

A deep historical perspective should also allow the decision-maker to avoid outcome or retrospective bias, or fall into the trap of what I call “understanding the Third Balkan War.” As former National Security Advisor Sandy Berger pointed out: “History is written through a rear-view mirror but it unfolds through a foggy windshield.” If the past is to be of use to policymakers, it must be exploited in a way that avoids what economists call “the curse of knowledge,” or that cognitive bias that emerges that in hindsight, the outcome of a historical event was more predictable than was likely the case. Since we know how past events have turned out, we can easily assume that the causal path that led to the event was inevitable. But most complex and difficult policy choices involve what former Secretary of State Henry Kissinger has called “51/49” decisions: In other words, it is very difficult to know, a priori, whether a difficult policy choice will turn out correctly, even if in retrospect it seemed obvious. This is true for good policies as well as bad, which an immersion in history and an understanding of the past should tell us…..

Investors are in a way historians too. They study past events and extrapolate them into the future. They also suffer from the same challenge: the outcome of past events appears abundantly clear while the future is murky and obscure. Most investments are “51/49 Decisions”, hopefully with better probabilities, but still uncertain outcomes.

As with leaders of state, we face an uncertain future. Most important is often broad-based policy, or strategy, rather than specific actions. To use a farming analogy: investors need to till and feed the soil, creating fertile ground to sow seeds and wait for opportunities to grow. All the while exercising discipline to eliminate weeds and pests before they can spread and hurt your portfolio.

Source: Thinking Historically: A Guide for Strategy and Statecraft

I’m beginning to sound like Chauncey Gardiner, the slow-witted gardener played by Peter Sellers in the 1979 motion picture Being There (1979), who through a case of mistaken identity becomes a close advisor to the US president.

India: Sensex finds support

India’s Sensex corrected sharply but found support at 26000. Descending Money Flow still signals selling pressure but a trough at the zero line would reverse this. Recovery above 28200 would suggest another advance, confirmed if we see a breakout above 29000.

Sensex Index

China: Shanghai breakout

Shanghai Composite Index broke through resistance at 3100, signaling a primary up-trend. Rising Twiggs Money Flow confirms strong buying pressure. Target for the advance is 3400*.

Shanghai Composite Index

* Target medium-term: 3100 + ( 3100 – 2800 ) = 3400

Europe quietly strengthens

Dow Jones Euro Stoxx 50 remains trapped below resistance at 3100, ranging between 2900 and 3100 for most of the year. Rising Twiggs Money Flow indicates buying pressure, however, and breakout above 3100 would suggest the start of a primary up-trend.

Dow Jones Euro Stoxx 50

Equity Prices Falter in Advance of the Elections | Bob Doll

From Bob Doll at Nuveen:

….we think it is more likely than not that Hillary Clinton will be elected president. Regardless of voters’ opinions, Clinton’s policies would be more predictable than those of Donald Trump, and if there is one thing that financial markets like, it is predictability. If we are wrong in our forecast, and Donald Trump does win the election, we expect additional volatility and a likely sell-off in risk assets. In this case, we would maintain positions in equities and other risk assets until there is greater clarity about Trump’s policies.

Secondly, and more importantly, we expect markets will again focus on fundamentals after the election. And fundamentals point to an environment that should be conducive to better performance for risk assets….

The market seems to be betting on a Clinton win, judging from today’s rally, but this is still a close race.

Source: Weekly Investment Commentary from Bob Doll | Nuveen

ASX 200 about to fall

The ASX 200 is testing primary support at 5200. Decline of Twiggs Money Flow below zero, following a large bearish divergence, warns of strong long-term selling pressure. Breach of support would signal a primary down-trend with an immediate target of 4750.

ASX 200

Dow breaches 18000

Dow Jones Industrial Average broke support at 18000, warning of a test of primary support at 17000. Bearish divergence on Twiggs Money Flow indicates long-term selling pressure. Recovery above 18500 is now unlikely but would signal another primary advance.

Dow Jones Industrial Average

19 billionaires who used to be dirt poor

Nothing to do with investment, but I find these rags-to-riches stories inspiring. They are also the best refutation of Thomas Piketty’s theory*:

Not every billionaire was born with a silver spoon in their mouth. In fact, many came from nothing at all.

The “rags-to-riches” trope may be a cliché, but it’s one that’s definitely grounded in reality. Through extraordinary grit and perseverance, individuals across the globe have beaten the odds and achieved their own rags-to-riches stories.

Here are 19 people who started off life poor and went on to become billionaires.

Starbucks’ Howard Schultz, now worth $US2.9 billion ($3.8 billion), grew up in a housing complex for the poor.

In an interview with the Mirror, Schultz says: “Growing up I always felt like I was living on the other side of the tracks. “I knew the people on the other side had more resources, more money, happier families. And for some reason, I don’t know why or how, I wanted to climb over that fence…..”

Source: 19 billionaires who used to be dirt poor

* In his 2013 book, Capital in the Twenty-First Century, French economist Thomas Piketty suggests that concentration of wealth grows when the rate of return on capital (r) is greater than the rate of economic growth (g) over the long term. His “silver spoon” theory, that the primary cause of inequality is the high rate of return earned on inherited capital, doesn’t seem to fit with the high number of rags-to-riches stories in the Forbes List.

Some concentration of wealth is due to inherited fortunes, like the Walton and Mars families, but many of these are only second or third generation. Far more are first-generation wealth like Bill Gates, Jeff Bezos and George Soros.

Will Durant (The Story of Philosophy) has a far simpler explanation:

“Nature smiles at the union of freedom and equality in our utopias. For freedom and equality are sworn and everlasting enemies, and when one prevails the other dies.”

While I believe inequality is a necessary price to pay for freedom, we need to ensure that the wealthy do not exert undue influence over the political system. Else inequality can get out of hand and lead to the collapse of freedom, either by dictatorship or a populist revolt.


India’s Sensex continues to consolidating above support at 27600 after breaking below its trend channel. Bearish divergence on Twiggs Money Flow warns of long-term selling pressure. Breach of 27600 remains likely and would signal a correction to 26000.



Hong Kong’s Hang Seng Index is testing support at 23000. Breach would warn of a correction to test the long-term rising trendline. Declining Twiggs Money Flow indicates medium-term selling pressure. Breakout above 24000 is unlikely but would signal a fresh advance.

Hang Seng Index

The Shanghai Composite Index is again testing resistance at 3100. Breakout is likely and would signal a fresh advance, offering a target of 3400.

Shanghai Composite Index


Germany’s DAX is testing resistance at 10800 after a shallow, saucer-shaped correction. Declining Twiggs Money Flow has leveled off above zero. Breakout would signal a primary advance with a target of 11500*.


* Target calculation: 10500 + ( 10500 – 9500 ) = 11500

Footsie bullish

Narrow consolidation on the FTSE 100, below long-term resistance at 7100, is a bullish sign. The decline in Twiggs Money indicates medium-term selling pressure, not long-term. Breakout above 7100 would offer a long-term target of 8000. Retreat below 6900, however, would warn of a correction to 6500.

FTSE 100

ASX Banks: Picking up pennies in front of the bulldozer

Earlier this week I wrote:

“The ASX 300 Banks Index broke through resistance at 8000. Twiggs Money Flow is still negative but recovery above zero now looks likely. Breakout would signal an advance to 8700 but I remain cautious and would wait for a retracement to respect the new support level.”

ASX 300 Banks Index

The picture changed within 24 hours. Breakout transformed into a false break, reversing below the 8000 support level. Twiggs Money Flow turned down and now recovery above zero looks unlikely.

Trading breakouts is like picking up pennies in front of a bulldozer. Especially when fundamentals offer scant support. I have never done an accurate count, but for every successful breakout there must me at least five, if not ten, false breaks and/or bull or bear traps. Not good odds if you want to preserve your capital. Far better to wait for confirmation, even if that means a higher entry price.

Bob Doll’s bullet points

From Bob Doll’s weekly commentary for Nuveen Investments:

  • Third-quarter earnings started strong. Should this persist, it may mark the end of the earnings recession.
  • It looks likely that Hillary Clinton will win the presidency while the House remains in GOP hands.
  • Equity markets face near-term pressures, but the economic and earnings environment should provide tailwinds….

Bob is right that earnings excluding the Energy sector are improving. The graph below compares As Reported earnings per share (EPS) for the S&P 500 to those excluding the Energy sector.

S&P 500 Index

But while EPS may be increasing, profit margins are shrinking. Which makes me wonder how long EPS will continue to rise.

Profit margins (after tax) per unit of gross value added

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Footsie faces stubborn resistance

The FTSE 100 is testing long-term resistance at 7000/7100. Declining Twiggs Money warns of selling pressure. Retreat below 6950 would warn of a correction to test 6500.

FTSE 100

The quarterly chart below shows the FTSE 100 first tested 7000 resistance in December 1999, reaching a high of 6950, and has struggled to break clear of this level ever since.

FTSE 100

With the pound approaching record lows from 1985, and exports expected to rise, the Footsie finally has a decent chance of breaking clear.


DAX levels off

Germany’s DAX is consolidating between 10200 and 10800. Declining Twiggs Money Flow has leveled off above zero. Recovery above 10800 would signal a primary advance with a target of 11500*.


* Target calculation: 10500 + ( 10500 – 9500 ) = 11500

China breakout is likely

Hong Kong’s Hang Seng Index is consolidating between 23000 and 24000. Decline of Twiggs Money Flow has slowed and a trough above zero would indicate long-term buying pressure. Breakout above 24000 would signal a fresh advance. Breach of support at 23000 is less likely but would warn of a correction to test the long-term rising trendline.

Hang Seng Index

The Shanghai Composite Index made a flat saucer-shaped correction before again testing resistance at 3100. Breakout is now likely and would signal a fresh advance.

Shanghai Composite Index