Management Hubris - India Decoupling Stock Market Will Be A Myth

How ironic that HDFC's Aditya Puri's article prints today just when the China market is down roughly 5%.

Here is the link to HDFC Aditya Puri article "Decoupling is set to become a reality soon" a self serving media spin article by the head of HDFC Bank

I am going to deconstruct his comments.  Mr. Puri makes the argument - correctly - that European and American economies are struggling and the world has changed structurally.  True, no arguments there.

The financial markets, however, are slow learners, creatures of habit, and therefore, create confusion in the short-term or transition (defined as volatility) period.

Really? I would love to know when the markets corrected in Nov 2007 they foresaw a correction ahead in 2008.  I do not know if Mr. Puri made any such calls and protected his stockholders.  Fact is that yes, markets do forecast 9 of the past 5 recessions but they usually are smarter in sum than any one individual.  Anyone that considers himself smarter than the market is suffering from a God complex and has an ego problem.

The forecast GDP growth rate during the next 3-5 years for the following countries are (%): US: 1.8; Europe: 0.8; East Asia: 8; China: 8.5; India: 8. This reflects the level of structural adjustments required in the Western countries in terms of asset bubbles, financial contagion, stimulus, exchange rate, etc. 

I am stunned that any corporate executive would be out there spewing forecast statistics, that too from economists? Economists forecasting record for this cycle and most cycles in my lifetime has been dismal.  The fact that economists are forecasting 8% growth rates for Asia is meaningless.

These same economists were forecasting similar forecasts for Japan in the late 80s and the Tiger economies in the mid 90s.

Besides, investors seeking higher returns on their investment will flock to Asia; this will result in a flood of capital and Asian currencies will see a phase of secular rise against their G-7 counterparts. This could erode export competitiveness, and economies within Asia such as India and Indonesia that are more internally focused, will outperform the others.

Yes, investors will probably flock to Asia to seek higher returns.  However, in a bear market, there are no safe havens.  Just as almost every company benefited during the bull market from global market expansion, what I am seeing today is that there is deflation in Europe and the U.S. and wages are falling dramatically in these countries while wages are rising and inflation is rising in India and China.

Further, Europe has exported a 20% decline in its currency, the net result of which will be a deterioration in competitiveness for India and China.

It is shocking to me that the CEO of one of our major banks does not recognize the risks posed by a rising Rupee.  The consensus today is that India will decouple.  The consensus will be proven wrong in the near future, yet again.

Mr Aditya Puri might want to check the performance of China over the past 12 months and would see that the present market correction / selloff initiated in China.

We are entering a phase where the recession is about to be exported to Asia.  Europe and U.S. have experienced significant declines and a severe recession.  However, a double dip is likely headed.  This time around, emerging markets will suffer along side global markets.

There is no decoupling. 

Here is the first piece of news that Mr. Puri would do well to read. 
Chinese growth May Slow

China Riverboat Gambler - Part II

Seems that rational people are arriving at a similar conclusion about China:

“China has embarked on a capital-spending bubble the likes of which the world has never seen,” famed short seller Jim Chanos claimed recently. “Buildings are going up with no tenants, roads are built with no traffic, shopping centers are built with no tenants or customers, yet they continue to be built and they continue to be planned.”
Heh, here comes the money shot:“China is Dubai times 1,000, if not a million,” he said. “At some point, all of this (ill-advised) investment will come home to roost.”

The China Bubble

The press is starting to warm up to our view that the Chinese situation resembles Japan in the 1980s. 

I'm not going to call it a bubble because the growth positioning of India is enviable, but the prices of property in Mumbai, Gurgaon and other parts of the country relative to income are astounding, humbling and shocking to me.

China rushes towards a Japan-style bubble

By Peter Tasker

Emerging markets, it seems, have had a good crisis. In contrast to the debt-ridden G7 economies, they have quickly resumed their growth trajectory. No surprise, then, that US emerging market mutual funds are experiencing record inflows. The stellar performance of the Brics markets - Brazil, Russia, Indian and China - is due to continue into the distant future.
Such is the narrative now forming among investors. To anyone who has lived through the rise and fall of the Japanese bubble economy, it should set off alarm bells.

Remember that it was in the years following the 1987 "Black Monday" crash that Japanese assets went from being expensive to absurdly overvalued and the Nikkei's dizzy rise to 39,000 forced the bears to throw in the towel.

Then, as now, the logic seemed unassailable. While the western world was stuck in the post-crash doldrums, the Japanese economy had got back on track with apparent ease. Japanese corporations were using their high market capitalisations to finance acquisitions of foreign trophy assets. Japanese banks boasted the world's strongest credit ratings.
But what you saw was decidedly not what you got. The crisis, far from leaving Japan unscathed, exacerbated its structural problems and laid the groundwork for a far greater disaster. And it was the weak western economies, not Japan, that produced healthy investment returns over the next decade.

In reality, 1980s Japan was never going to be terminally damaged by weakness in export markets. Its current account surplus and strong fiscal position provided the macro policy leeway to make any slowdown strictly temporary. The Bank of Japan duly put the pedal to the metal and the recently deregulated banks went on a patriotic lending spree. High-end consumption boomed but the real action was in the asset markets and capital investment, which soared as a proportion of gross domestic product.

Sound familiar? It should, because the same dynamic is evident today in China and some other emerging economies.

At the 2008 peak, the price-to-book ratio of the Shanghai stock exchange was over seven times, well above the five times achieved by Japanese stocks in 1989. After the turbulence of the past 18 months, the ratio has fallen to 3.3 times, still the world's second highest after India, and residential real estate trades at multiples of income that make the US housing boom look tame.

Why would China's rulers embark on a such a disastrous course? Because the alternative - unleashing deflationary forces stored up over years of mercantilist policies - would be too painful to contemplate. That was the choice made by Japanese policymakers, who had 100 years' experience of managing a quasi-capitalist economy.

While we can call these bubbles, based on anecdotal evidence emerging markets investors are convinced that they have survived and are immune to what ails the first world.  Time will tell, but a nagging feeling tells me I've seen this story before.

China : When the Driver of the World Economy Is A Speculative, Drunk, Riverboat Gambler

It is our opinion that China today is circa Japan in the late 1980s when it was a manufacturing powerhouse and seemed poise to continue its rise to superpower and world domination.

Jim Grant, Grants Interest Rate Observer: 

“China today is where Japan was in the late ’80s, except with the greater political instability that comes with a semi-controlled economy and the lack of a social safety net (read: jobless, hungry people don’t write angry letters, they riot)…Today China projects to the world a similar image as Japan did in the 1980s… “

Richard Bernstein, former chief investment strategist at Merrill Lynch, says China’s economy is overheating and that investors should avoid its stock market. “China is an immense credit bubble that's going on right now,” he tells CNBC.   "They have massive overcapacity and their solution to that problem was to build more capacity over that," says Bernstein, now CEO of Bernstein Capital Management.

 “A superb primer on the risks of China’s go-for-broke lending drive was published by Fitch Ratings on May 20. Is it not passing strange, the agency asks, that Chinese lending is accelerating even as Chinese corporate profits are shrinking? ‘Ordinarily, falling corporate earnings are met with tightened lending, but in China, precisely the reverse is evident. . . .’ You would expect—and Fitch does anticipate—that the borrowers of these trillions of renminbi are not so profitable as they were in the boom, and some will therefore struggle to service their debts.”


Lately, the Chinese economy has been impressing us with its growth…But Chinese economic structure is not is not superior to the West’s; the Chinese can just cook GDP numbers better and control their economy more effectively through forced lending and spending.
However, these short-term advantages come with long-term consequences – there will be a steep price to pay for them; there always is. 




“Examining, first, the track of Chinese bank lending and, second, the trend in Chinese nonperforming loans, the seasoned reader will remember … Drexel Burnham Lambert. In the mid-to-late 1980s, the American junk bond market combined breakneck growth with muted default rates. The secret, fully revealed during the subsequent bear market, was that the default rates were a direct product of the issuance rates. Borrowers didn’t default because of—to adapt the Fitch formulation to that earlier time—the ‘pervasive rolling over and maturity extension of bonds as they fell due.’ Drexel failed when the junk market did.

“Since 2005, China has generated 73% of the global growth in oil consumption and 77% of the global growth in coal consumption.”

Today, Chinese economic growth is the force pushing the global economy and stock markets. The quality of this growth, however, is low as it is predicated on massive (forced) lending and is unsustainable. As and when Chinese growth finally slows, the impact will be felt in many, often unsuspected places.

We believe that China’s pulling in the reins will impact commodity markets, commodity producers and commodity exporting nations. Combined with our expectation of deflation in the intermediate term, this will severely impact commodities.  Let’s take oil, for instance. As incremental demand from China slows, oil prices will suffer and impact the Russian economy in particular.  China accounts for 15% of Brazil’s exports (up from 1.5% a decade ago), significantly impacting the economy of that South American nation.


Finally, we are bearish on China because of the enormous amount of overcapacity that currently exists in the country.  China’s manufacturing capacity was structured for a leveraged U.S. consumer and a leveraged world.  As the world delevers, China as the exporting nation faces a difficult transition given it’s excess capacity.  Like the U.S., it is desperately attempting to reflate its economy and continue growth is because it sees the difficult adjustment that lies ahead.