Five Perspectives on China’s “Investment Bubble” | Enterprising Investor.

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Finally, I love that they used a Waterhouse painting (as above) to emphasize these points.

Avoiding the Siren Song of Emotions: Notes from the Wealth Management Conference | Enterprising Investor.

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Today a Wall Street Journal story highlights that allowing wealthy foreigners to immigrate to the US may be more of an opportunity than many know–under the proper conditions, of course.

It should be no surpise that many wealthy Chinese want to come here. It should be no surprise that many wealthy individuals from all over the globe want to live here. US policy makers can ethically exploit that desire to solve many of our economic problems.

I never understood why, since the 1960s, our immigration policy seems to be bent on ensuring that the least-favorable immigrants–from an economic perspective–receive an advantage over the most-favorable.  Most entrpreneurs, science and math PhDs, and artists would love to be US citizens and it is highly likely that they would add more value in their fields here than in the country where they currently live. Why does our immigration policy favor those who have not had that kind of success and who come here with more needs than contributions? It is only politics at this point.

http://online.wsj.com/article/SB10001424052970204394804577011760523331438.html?KEYWORDS=Chinese+millionaires

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I, however, think a better idea would be to place these wealthy families at the top of the INS list and invite the whole family to receive citizenship as soon as possible, assuming that they are not security risks. We could probably solve the current US financial cirsis/housing depression overnight if we simply required these wealthy people to buy a house with at least 40% in unborrowed capital and own that house for, say, seven years. Of course, making citizenship contingent on keeping a job and buying health insurance could be another stipulation. And, that says nothing about the productive capacity that we would add to US rsources after they move here. We all benefit when productivity rises, even when our own productivity is stagnant.

Visit msnbc.com for breaking news, world news, and news about the economy

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The plan is amusing to me, though I should not feel amused at all today because my net long exposure is the lowest it has ever been. That means that we are only minimally participating in the euphoric 13% rise in the US equity markets this month…a moon shot, really. In fact, we used today’s blast off to sell out of some long-held positions because they reached our estimate of intrinsic value. At this rate, we could be net short by the end of the year.

If the market holds here, it will be the market’s best month since an 11% rise in December of 1991. For some perspective, in December 1991, the eastern European countries were becoming acclimated to their new-found freedom and it was shortly after the US and coalition forces defeated the Iraqi army in Operation Desert Storm with minimal resistance. So, it was a time of great optimism. In fact, the market rose 31% that year. (Update: Jason Zweig just re-tweeted (http://twitter.com/#!/jasonzweigwsj): “Only 2 months since 1950 where S&P 500 has been up, for the month, more than current MTD – Jan 1987 & Oct 1974 (+13.2 & +16.3%, respectively)”)

The most amusing thing about the optimism surrounding the bailout plan is how much work is left to be done. The first thing I thought about when I heard the details (or lack of details) is Steve Martin’s SNL monologue in January 1978:

You.. can be a millionaire.. and never pay taxes! You can be a millionaire.. and never pay taxes!

You say.. “Steve.. how can I be a millionaire.. and never pay taxes?”

First.. get a million dollars.

Now.. you say, “Steve.. what do I say to the tax man when he comes to my door and says, ‘You.. have never paid taxes’?” Two simple words. Two simple words in the English language: “I forgot!”

When the Euro ministers go to the Chinese to get a trillion euros, will the Chinese actually give it to them? Details. And, if they do, and the Chinese come knocking on their door later to retrieve their capital along with a hefty return, will the ministers simply say, “I forgot?”

As Bob Pisani said today on CNBC, Italy is due to roll over 200 billion euro of debt early next year, which equals all of the capital that was dedicated to the EFSF last night. Details.

I have analyzed risk my entire career. The following is the first question that people like me ask when someone comes to us with a deal that the seller considers too good to pass up: “Why am I so special that I am going to get access to this great opportunity? What is it that I can bring to the table that makes me special?”

If you can only bring money to the table, then look out because money is completely fungible and they must think that you are the mark. The European ministers must be hoping that the Chinese and others don’t ask that question. Either that, or the Chinese (and others) are about to buy at very low prices some Greek Islands, the Vatican, the south of France, the Louvre, Daimler and BMW, some patented British and German aerospace and defense technology, and a few other Euro businesses, intellectual property, and hot spots.

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“…the fact he is seeking cash from any source is somewhat encouraging.”

A closer look will reveal that the last time Klarman sought capital was early 2008, which Klarman verified in a speech that I attended at the CFA Institute’s Annual Conference in 2010. He raised that cash in early 2008, not because he wanted to put that cash to work immediately, but because he felt it was highly likely that markets would become distressed soon and that the best time to raise capital was before they became distressed.

For example, I tried desperately to raise capital for the first time in late 2008 and early 2009. I would eventually be more than fully invested by March of 2009 as I exploited all of the bargains that existed in that period. But, it was too late to raise cash in late 2008 and early 2009 when the best opportunities were just sitting there; trying to raise capital to invest was nearly impossible given the rampant fear.

As any good contrarian would, Klarman waited until the markets became distressed in late 2008 and then put all of that fresh capital to work.  When Jason Zweig asked him at the CFA conference how easy it was for him to do that given all of the fear that existed, Klarman said it was remarkably very easy for him. I agree, the amount of low-hanging fruit was remarkable, which was why I went all in and even used leverage for the first time in the first quarter of 2009.

The point is this: the author of the attached story has it wrong. Klarman is not seeking fresh capital because he believes that there are plenty of bargains available now, which would be an encouraging sign. No, Klarman is seeking fresh capital now because he believes that markets will soon become distressed again. He will bide his time until then, and then he will pounce.

That is exactly what we are doing….again. We are nearly at a net long position of zero, the lowest since launching the fund. We have plenty of cash and shorts waiting for what seems like the most-telegraphed debacle in a long time. People do not change their behavior overnight on their own volition, but a massive change in perspective and behavior is what is required to make a real, permanent fix in the global economy.

Equity is going to have to be king again and that equity is not going to come from China, much as the optimists are hoping; it is going to have to come from savings and retained earnings, which is going to require a new way of viewing the world and of operating. Because most around the globe believe that they are entitled to much more than what they can earn, the disruptive forces could be devastating.

One important note: We are not macro investors nor do we place much weight on forecasts. In fact, we believe it is best to ignore forecasts and search for value company-by-company from the bottom up–to seek asymmetric opportunities–which is exactly how we operate. Our research is uncovering few bargains–few asymmetric opportunities that have a high margin of safety–so we think risks are high. To manage risk, we focus hard on seeing the world–the big picture–as it exists today based on facts that are knowable today, not forecasts. The biggest risk is not volatility, but high levels of asset prices relative to knowable, fundamental values–the lack of a margin of safety.

Those who think that the Mr. Market has already factored a debacle into asset prices must explain why, in equity markets, the CAPE is way above its historical average and Tobin’s Q is near its all-time high except for the peak reached during the dot com bubble. They must believe that one of the most outstanding spurts of global growth in history is just around the corner, as if the cotton gin, combustion engine, or microchip were just invented last month and will be put into mass production this month. Is the iPhone 4s or iPad 3 the equivalent of the cotton gin?

http://www.institutionalinvestor.com/Article.aspx?ArticleID=2919905&LS=EMS579703

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First, from my perspective, Scott Shellady, a pit trader in Chicago, was spot on this morning on CNBC when he called the optimism over Europe, “Hopium.” The hope that people have of a very positive outcome in Europe may not be based on opium consumption, but something similar—just hope. Any news is greeted positively and all bad news is ignored. When most market observers think that Greek debt needs to be haircut by 60- to 70-percent but European banks are objecting to any haircut over 21- to 30-percent, how can any news be good news? And, Greece is just the tip of the iceberg. (Sorry, no video.)

Shellady also thinks the 30% drop in the VIX in the last eight trading days is a sign of weakness, not strength. Strong markets move in a steady, upward fashion.

Second, is a Wall Street Journal Market Beat column that was published online this morning. In it, the Economic Cycle Research Institute (ECRI) finds that their leading index is “rolling over even harder, suggesting a deeper slowdown ahead even as trailing economic data are coming in better than expected and the stock market rallies.” I am not a fan of economic and market forecasters, but according to The Economist the ECRI has “never issued a “false alarm” on a recession call” and it has been around since the 1960s.

http://blogs.wsj.com/marketbeat/2011/10/14/ecri-leading-index-keeps-getting-worse/?KEYWORDS=ECRI

Finally, with the focus on Europe, we seem to be forgetting other parts of the globe. A piece in today’s Wall Street Journal by John Bussey discusses the very serious threat that the Chinese government is to foreign businesses. It reminds us that china is a tough place to do business because there is no rule of law. It reminded me that my friend and former colleague James Penrose, circa 1994, criticized the Chinese government for abrogating a valuable real estate lease that McDonalds Corporation possessed in China. His criticism made the front page of the Wall Street Journal Asia the next day. Nothing has really changed in seventeen years with respect to the rule of law.

http://online.wsj.com/article/SB10001424052970204774604576629200721570470.html

I worry about my own confirmation bias. I think I will start a new feature soon called Counterfactual Friday in which I write about the rationale behind the opinion of everyone who disagrees with my thinking and write about the facts that undermine my thinking.

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Still, for the market to avoid moving downward toward its fundamental averages, one would have to expect significant positive economic developments in the near term such as skyrocketing productivity, job growth, and earnings growth. Is there anything on the horizon that makes you feel that these positive developments are just around the corner?

Media explanations for daily market price movements are usually vague guesses, but it seems there are plenty who are willing to bet their clients’ money on it. It seems there are many people holding out hope for some kind of deus ex machina so that just about any rumor helps the market temporarily avoid its fate.

Here is an explanation from today’s Dow Jones Newswire’s Market Talk Column for today’s late swing in the market:

4:05 (Dow Jones) US stocks pull a fast one – a very fast one – in the last hour, rallying almost maniacally in the last 10 minutes of trading to finish higher after falling sharply in the morning. DJIA jumps 69 (0.6%) to 11061, after sliding as much as 168 earlier; S&P 500 gains 8 (0.7%) to 1162, Nasdaq Comp rises 27 (1.1%) to 2495. Fears of Greek default drove morning’s sell-off. Rumors in the afternoon that – wait for it – the Chinese would buy (or are buying) Italian debt seems to have driven the rally.

A rumor that the Chinese may buy Italian debt is the deus ex machina for the world economy?

The problem in Europe and the rest of the developed world is a decades-long lack of productivity combined with a population that expected much. We all wanted something for nothing. Up until now, politicians in the developed world made many promises to their constituents and only asked for office in return. Those promises resulted in policies that helped accelerate our resource consumption from the future to the past and present.

For example, in the US think of long-term policies such as Social Security; Medicare; subsidized housing in the tax code; tax policies that favor debt over equity; etc.; and short-term policies such as cash-for-clunkers. Each allowed individuals or corporations to:

• avoid saving for retirement;
• avoid saving for medical care that will surely be needed one day;
• avoid saving for a large down payment on a house or car; or
• encouraged the use of debt to expand or buy a business

In each case, more wealth could be exhausted earlier in one’s life than it could without such policies. In each case, a larger amount of resources are guaranteed to be exhausted in the future to pay for present consumption, which of course means less will be available for future consumption of anything.

Those promises also created incentives for people to shun the productive work that leads to real wealth creation and created incentives to simply seek handouts. But, that can only go on for so long and now it is time to pay the bills.

I need to understand how that translates into the optimism that is keeping the market floating above its long-term fundamental averages. How does receiving a large bill for prior consumption make one optimistic about the economy and the market in the near future? How is that bill going to be paid, if not with long-deferred gratification? Do you think dumb-money, say from the Chinese, will pay the bill free of negative conditions? I do not. What exactly can Italy offer the Chinese? And then, which trap door will the deus ex machina come from for Greece, Ireland, Spain, the US, Japan…

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(H/T: Global Association of Risk Professionals (GARP) eNewsAlert).

http://www.garp.org/news-and-publications/overview/story.aspx?newsId=30570

China’s local governments amass debt
Tuesday, June 28, 2011

By David Pierson

Chinese local governments have taken on $1.65 trillion of debt with little regulatory oversight, an official audit found, raising concern about how much of the money will be paid back.

Some of the funds raised were improperly funneled into the stock market and the country’s overheated real estate sector, according to the first-of-its-kind review by China’s national audit office.

About half the debt, which was measured as of the end of last year, was incurred after Beijing in 2009 allowed banks to issue a record amount of new credit to stimulate the economy. Provincial, county and city level governments borrowed heavily to fend off the effects of the global financial crisis.

The total local-government debt is equal to about 27% of China’s annual gross domestic product. By comparison, there was an estimated $2.93 trillion of U.S. municipal bonds outstanding at the end of 2010, about 20% of the U.S. GDP last year.

Nearly half the debt was issued through thousands of local government investment companies whose borrowing would not show up on municipal balance sheets.

Beijing cracked down on the most troubled investment companies last year, ordering banks to stop issuing credit to them.

The huge obligations could pose a risk to China’s economy, which is bracing for a slowdown this year as it battles its highest inflation in nearly three years.

To pay off the loans, governments have relied increasingly on sales of local land to developers.

Some infrastructure projects such as highways and rail that received much of the borrowing’s proceeds won’t be profitable for years, increasing the likelihood that they could default on their loans.

“The ability of some [local governments] to repay the debt is low,” said Liu Jiayi, the country’s auditor general. “There are hidden risks.”

Chinese policymakers can avert a crisis if they move to allow the debt to be refinanced, said Qu Hongbin, co-head of Asian Economics Research for HSBC.

“Although the size is still manageable, Beijing needs to take immediate action to restructure these debts to mitigate defaulting risks,” Qu said.

About 37% of the total debt went toward infrastructure construction, 25% went to public transportation, 11% was used to buy land, and about 10% was spent on education, subsidized housing and healthcare, the audit said.

A lack of regulation allowed municipalities to lie about the value of their collateral and about their ability to pay off the debt and to steer the money borrowed to the property and stock markets, the auditors said.

david.pierson@latimes.com

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He has an interesting tid bit in today’s post: China consumes two-thirds of the world’s production of iron ore.

Given the number of ghost cities in China, for how long?

http://www.dailymail.co.uk/news/article-1339536/Ghost-towns-China-Satellite-images-cities-lying-completely-deserted.html

This is going to end badly for many.

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