Mr Market is giving investors a lesson

Aug 27, 2015

- By Bill Bonner

Bill Bonner
Delray Beach, Florida

Dear Diary,

The Donald breathed a sigh of relief yesterday. He and other rich people got a break from the beating they've been taking; stocks bounced, with the Dow up more than 600 points.

(A dear reader corrected us. Donald Trump did not go bankrupt personally. His projects went bankrupt. And only a few out of many. He is not the reckless hustler we made him out to be, in other words. Instead, he is a prudent, calm and rational businessman who is merely reacting to the opportunities and challenges that come his way.)

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Yesterday's bump up confirms the mainstream view: that there is nothing to worry about; this is just a case of nerves, not a sign of epizootic. Here is US Trust reassuring its customers:
    The action in the past few days has been based on fears that we will revisit the market environment from 1997 to 1998, in which the Asian currency crisis led to a sizable correction in world equity markets. A second breakdown in energy, a continued fall to record-low prices in many commodities, and a deep drop in emerging market currencies and equities are sparking fears that a global growth recession is coming our way. And add to that the fact that investors are worried that the Federal Reserve (Fed) may tighten into a large-scale slowdown is increasing the flight to safety. Back-end rates have declined as the dollar has strengthened again and risk aversion has risen. The 10-year yield in the U.S. is now close to breaking 2%. The Fed does not control the back end, so concerns are rising that if we get a growth recession and a flattening curve with tighter policy then cyclical assets are very vulnerable.

    We do not agree with the ultimate conclusion of a recession preceded by a financial crisis that some are discussing. Market technicals do not look good and seem to be deteriorating, but the fundamental backdrop, the policy backdrop globally, and now valuations are actually improving in most economic regions. China and the emerging markets (EMs) are certainly still slowing, but the developed world is on its way to a higher gear.

US Trust, like Donald Trump and much of the media, blames the Chinese for the recent sell-off. Emerging market economies are slowing, they say, while the US and developed economies are moving into 'a higher gear.'

'Higher gear'? As near as we can determine, the gears have been stripped.

But let's turn back to the Chinese. How come they're downshifting? Well, it appears that they borrowed too much, over-built, and over-speculated - just like Mr. Trump. And just like the US.

And now that Mr. Market is giving investors a lesson, the Chinese authorities are desperate to close the schools - just as they are in the US.

Mr. Trump should be delighted with the Chinese. At least they still have some tools available for more mischief. Their key lending rate is still over 4%; in the US it has been near zero for 6 years. And they're willing to do anything - no matter how absurd - to keep their stocks over-priced. They've even made it a punishable offense to say anything about it.

No kidding. Our analysts in Beijing have to watch what they say for fear of being arrested. This shows that the US is a more advanced economy; when it comes to misleading investors, we rely more on fraud, and less on force. But hey..let's cut the Chinese a little slack; they haven't been running a market economy for very long. They still have a lot to learn. When you falsify price data - by manipulating markets - for example, you do not make stocks more valuable. You simply make them less attractive to sensible investors. In the short run, price increases look like good news. Investors give each high fives. Commentators blab about the 'strength of the US economy.' And the public believes it is better off. But mispricing capital assets is a sophomoric mistake. As we have seen in both China and the US, it draws real resources into dumbbell investments and over-production. In the US, we have more shopping malls than we need. In China, they have too many factories. (We are, of course, just guessing...only Mr. Market knows for sure. And in both places he has been gagged by the central government.)

The real problem in both economies is too much debt (and other debt-like claims on output). Debt has distorted the economy and the capital structure, leaving over-capacity in some key industries and over-priced asset prices - stocks, bonds, and real estate - almost everywhere. And now that Mr. Market is beginning to speak his mind, the authorities are rushing with more gauze and duct tape.

Recently, in New York, friends asked our advice.

"Should we invest in the stock market?"

The question came from people who have been quietly buying old houses and commercial property in the Tivoli area...fixing them up...and renting them out. The area, as near as we can tell, is attracting more and more weekenders from New York City...and holding on to quite a few hipsters and philosophers recently graduated from Bard College. It is 'up and coming' with good restaurants and bars, attractive 19-th century Hudson Valley architecture and a relaxed small town feel to it.

When asked to give us numbers, they replied:

"Well, things around here are getting pretty expensive. But we can still buy an old house for $180,000...we put in about $30,000 in repairs (they do much of the work themselves)...and rent it for $2,000 a month."

This sketch of their business was not detailed enough to calculate a precise return on investment. But the figures sounded good to us.

"If I were you," we said, "I'd just keep doing what you're doing. You're getting a decent return on your money. And it is less crony-dependent than the stock market. You understand what you're doing. You control your time and your investment. You don't need Janet Yellen or the Chinese central bank to protect your investment.

"You're probably buying as cheap as anyone and spending less than your competitors on renovation and maintenance. You're not likely to do better than this in the stock market. Besides, your investment in stocks could disappear. This isn't going away."

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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