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Before I talk about why I am bullish, let’s see why investors are bearish from May to Oct:
Over history since 1977, equity under-performs bonds from May to Oct. On average, equity made 3.33% while aggregate bond market made 11%. The equity market has been bull for 30 months since 2012, historically 10% correction happens every 18 months. Most fund managers tend to follow history and going to put money at sidelines and wait until September / October this year.

Why bullish for rest in a longer view?
“Bubble” is usually a after-thought.  I think the bubble won’t happen because many reasons…

  • Fed will still artificially keep interest rate near zero till end of 2015, encouraging people to invest in riskier assets. Underlying economy is still moving upward though we have big bump like 0.1% GDP from Q1 and long-term unemployment issue.
  • U.S still has the strongest and most stable economy among all G20 countries while there are lots more wealth created in the world. Wealthy are always hungry for return.
  • Now we hear a lot of crash and bubble warnings while the market was relatively mute on crash and direction-ally bullish before 2007 financial crisis. So, the crash does not happen when many people are taking safety measures.
  • Technology stocks are valued near 30x P/E but still relatively cheap if you compare the valuation to 2000-2001. At that time, a lot of public Internet companies generated no revenue at all. The key is to identify ones which are going to be profitable soon.
  • Although the property sector and shadow-banking problems are real in China, Chinese economy will stabilize and go higher in the second half. Since April, we have seen a series of small stimulus announced by Chinese government. I believe hard landing is NOT going to happen in 2014. (I explain more in detail in this blog)
  • Lastly, although I don’t believe this — historically the mid-term election before the next U.S. presidential election will boost and carry the bull market longer

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Despite myriad concerns about Chinese stock markets, real estate and banking systems, the long view on China is still bullish. Before I talked about why “Hard Landing” is not plausible in China, let me discuss why people are worried about the current Chinese economy.

China Property Bubble Bursting

The discussion of “Hard Landing” in China started in 2012 when thousands of Chinese “Ghost Cities” phenomenon appeared in many tier 2 and 3 cities in China. The situation has not been improving since 2012.   The latest real estate and housing data released in China is indeed very bad.

According to FT report, the value of homes sold in the first quarter fell 7.7% yoy to 1.1 trillion yuan. New property construction starts fell 25.2% yoy to 291 million square meters – the largest yoy decline in quarterly data since at least 1997 and the lowest quarterly amount of new floor space started since Q1 2009. In 2014 Q1, there was 7.7% decline in home sales and developers have cut prices in at least five Tier 2 and Tier 3 cities.  Basically properties were overbuilt and the overcapacity situation probably requires 4 to 5 years to digest.


Source: FT

Because the government wants to crack down the shadow banking (estimated to top $5.8Trillion yuan) problem and cool down the overheated housing market, the central bank in China has tightened money supply and bank lending since Jan this year. A lot of the small business loans, especially real estate/property related loans are put on hold for more than 5 months.  The broadcast measure of financing for the economy fell 9.1% YoY in Q1 to 5.6 trillion yuan.

To make matters worse:  many property developers’ cash flows were squeezed by (1) declining home price and home sales in Q1 2014, (2) large land purchases in Q4 2014 (amount went up 41.7% YoY to 136 million square meters) and (3) financial lending is halted by government policy.

Why No Hard Landing?

The above property and bank loans problems seem bad enough to significantly slow down Chinese economy into a danger zone. The “Hard Landing” argument is alive and well. But keep in mind, the current so-called bubble and financial crisis is far from the 2008 US’s sub-prime mortgage situation. Here’s why:

1. Reform is Progressing From Investment to Consumption

The 2014 first quarter GDP data show progress of Chinese reform. The slowdown in GDP growth from 7.7% in Q4 2012 to 7.4% in Q1 2014, the lowest level since Q2 2012, appears to be largely consistent with policy goals of the Chinese government led by Premier Li Keqiang. The long-term goal of Chinese policymakers is to adjust the economic growth model from the current investment-led one to one driven by consumption.


There are three components that make up GDP – final consumption expenditure (consumption), gross capital formation (investment) and net exports (exports less imports). In the first quarter, consumption accounted for 76.7% of GDP growth, the second highest quarterly percentage in the recorded history. The first highest is 1985 (85.5%). Year-to-date retail sales expanded by 12% YoY while fixed asset investment growth slowed to 17.6% YoY from previous month. Industrial production accelerated modestly from 8.6% to 8.8%.

I am not sure the stock market in China is bottoming out but all these suggest that the economy is moving to the right direction, the soft landing scenario seems plausible.

2. Different Housing Market Characteristics in China vs. U.S.

We should understand that the Chinese housing market characteristics are quite different from those of U.S. First, Home ownership is perceived as a necessity, not a privilege or luxury. As such, owning a home is more important than owning a big home, especially for those young men eager to get married and start new families.

Second, Chinese people are buying properties with cash.  Even assuming there is some level of a housing bubble in China, it’s different from the housing bubble that plagued the U.S., in that residential mortgage debt remains relatively low. Chinese residential mortgage debt was 15% of GDP as of 2009, compared to 81% in the U.S., according to the Milken Institute.

In China, there is no Freddie or Fannie to virtually absorb all sour mortgages. A typical residential mortgage in China is a variable, 20-year loan. The 30-year fixed-rate, and enticing, non-transparent financial constructs such as adjustable-rate mortgages or interest-only mortgages are not available to most Chinese home buyers (yet). 

3. $3.8 Trillion Foreign Exchange

It’s not likely China will see a hard landing” akin to a meltdown given its $3.8 trillion foreign exchange cash pile and growing middle class. Yu Yongding, a former member of the People’s Bank of China ’s Monetary Policy Committee, says that those who argue for an imminent collapse ignore China’s unique economic situation. He says, “in the worst-imagined case of property prices falling by more than 50%, the government could purchase unsold properties and use them for social housing to support prices and reduce stockpiles while also using some of its nearly $4 trillion of foreign-exchange reserves to inject capital in the banks if they saw a huge rise in non-performing loans from bad mortgages.” His article, Rumors of a Chinese crash are greatly exaggerated, is very much worth a read.

4. Nine Targets in the Capital Market Reforms

Lately, Chinese stocks have not reflected the long-range growth optimism as global investors fear contraction but the recent capital market reforms should spur foreign investment and domestic economic activities.

On May 13, China’s State Council revised 9 guiding principles of regulations for the capital market reforms.  The 9 targets can be summarized into 4 areas. First, the government would open up China’s capital market to facilitate the cross-border investment and financing. Second, the government aims at promoting bond, equity, and private equity markets. Third, the government encourages mixed ownership economy, seeking to improve the modern enterprise system and corporate governance structure. Fourth, the government seeks to improve risk control, monitoring, and reporting to encourage higher innovation and more new products. 

The guidelines lain down indicate that the government acknowledges fair enforcement of rules and regulations are critical for healthy developments of the capital market.

Taking The Longer View

Despite the sour short-term news, the Chinese government is committed to growth in its long-range plans, and has ample cash to stimulate its economy, should it need to do so. The Chinese are still building infrastructure at a breakneck pace in western and rural parts of China, leading to construction of entire cities. Its long-term goal is to produce an economy driven mostly by domestic demand and not exports.

Although the hyper-growth of more than 10% is already in the past, at its current 7.5-percent expansion rate – compared to 2.5 percent for the U.S. and 1.2 percent for the euro zone – the size of the Chinese economy will eclipse America in roughly five years, possibly sooner, according to a projection by The Economist magazine.

In the interim, the Chinese government has tried to normalize the market as part of its economic reform – it will allow more badly-run state-owned businesses to fail and default on their bad debt. The shadow banking issue could be huge but the government will shrink the size of the problem in a manageable and controllable manner.  The Chinese will be ramping up production of everything from computers to vehicles. China may also benefit from falling energy prices and Western sanctions on Russian banks. And a slowly recovering United States and euro zone may only serve to keep China’s export machine humming.

BONUS. Side Note

Besides China and Hong Kong, the return of money to emerging markets in general and Brazil in particular has been well-covered in 2014 Q1. What other countries are working?

While lots of the emerging market economies are doing quite well compared to the U.S. so far in 2014, investors should diversify their portfolios with suitable emerging market exposure based on their risk profiles.

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Nomura (Japanese investment bank) chief economist Richard Koo has long been an advocate of more fiscal and government spending in US. This following video was shot in 2010 Sept but with double dip threat not far from us, a lot of what he said is still applicable in 2011.  I see this as a great advice to US policy makers.

In his recent interview with On Point on NPR public radio, he talked about the reason why Japan went into a 0% interest rate and 15,20-year long recession. He argued that Japanese government went through similar situation like US now, and the policy makers had a series of debates between more government stimulus and deficit reduction from 1997 to 2001.  Japan made the decision to cut deficit and government spending while the private sector was just coming out of a recession.  Once the gov cut spending, all private sector continued to heavily de-leverage on their balance sheets.  This mistake eventually led the deficit went up 65% instead of going down because the Japanese private sector shrank much quicker.  It means when private sector creates 4 jobs, government cut 1 job and the unemployment situation can hardly improved this way. It took Japan another 10 years to bring down the deficit. Richard warned the US policy makers to think twice and learn from Japanese mistake.

Says Koo:

Arguing need for longer-term fiscal consolidation is irresponsible. The insistence that fiscal consolidation is necessary in the longer term is like the doctor who, faced with a patient who has just been admitted to the intensive care ward, repeatedly questions the patient about his ability to afford the treatment.

This is both lacking in decency and irresponsible.

If the patient loses heart after learning the cost of the treatment, he may end up spending even longer in the hospital, leading to a larger final bill. Completely ignoring the policy duration effect of fiscal policy and constantly insisting on longer-term fiscal consolidation was what prolonged Japan’s recession.

For instance, it was because Japan’s policymakers refused to give up the medium-term fiscal consolidation target of achieving a primary fiscal balance by 2011 that the government stumbled from fiscal stimulus to fiscal retrenchment and back again and, ultimately, was unable to meet its fiscal targets even once in the last 20 years.

That is why Japan’s recession lasted as long as it did and why the nation’s debt has risen to some 200% of GDP.

Read more:

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Bill Gates (MSFT) tops Forbes‘ list of the 400 richest Americans for the 18th year in a row, adding another $5B to his fortune to amass $59B. Warren Buffett (BRK.A) places second with $39B after shedding $6B. Biggest gainers: Mark Zuckerberg, +$10.6B to $17.5B; George Soros, +$7.8B to $22B; Sheldon Adelson (LVS), +$7B; Jeff Bezos (AMZN), +$6.5B; Larry Ellison (ORCL), +$6B.

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With today’s Obama $1.5 trillion revenue increase plan, we will expect heavier taxes on wealthy Americans with over $250,000 annual taxable family income. Feel like this is a socialist plan but if you look at the total share of wealth, gain and loss from past 25+ year, I’d not argue that we need some sort of tax reform to fairly re-distribute the wealth, help majority of Americans to regain their wealth, and narrow down the poverty gap in the country.  However, I highly doubt Republicans will let it pass in the Congress.

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Steve Jobs launching the new iPhone version 1 in 2007

I guess the breaking news of this week, besides Bernenke’s Jackson Hole speech on Fri, is Steve Job’s emotional resignation of his CEO position at Apple. Since this news broke at 7pm EST, the stock price has been down 5-6% in after-hour trading, stay around 357.

My belief for tomorrow: many retail and value investors would buy at this dip, I doubt it will go below 340 (that’s 10% retreat). If you decide to join the crowd to buy at Apple’s dip tomorrow, my recommendation for short-term trading strategy is to set multiple limit buys starting at 355 to 340. Of coz, you can also buy the call options at that price and 3-month put at 400 to hedge.   Don’t feel too bad if you miss out on the dip though.

My long term view: Financially, we shall not see any big slow-down in the revenue growth or compression in profit margin. The recent Sprint’s iPhone 5 news and China expansion can boost the growth > 80% for next few quarters. Plus, consumers are buying the iPhone and iPad, not Steve Jobs (my mom don’t know who he is, be honest). If you look at technical and ratios, Apple has stayed around 14 P/E and maintained > 50% revenue growth in past 2 years, its stock just looks a bit undervalued now among other technology companies (e.g. Google).

My BIG concern is: many institutional investors are buying long-term innovation in Apple, not rosy financials. Jobs once said that Apple is a product company, he emphasizes on revolutionary design. The new CEO – Tim Cook is a operation/sales guy for 20 years. He would be a good CEO but I don’t know if he has the same level of creativity and revolutionary thinking as Jobs has. Being said, Apple may not have any more new successful products or innovative ideas next summer beyond new versions of iPhone and iPad.  Reviewing other products (like iCloud and AppleTV)  Apple introduced in the past 6-9 months, I haven’t seen strong pickup by the consumer market yet.   Can iPhone and iPad continue bring 50% revenue growth in next 10 years? I doubted. This becomes a big discount in long-term valuation.

Another minor concern I have is: whether Apple will have changes in their management team or some executives leaving in next 6 months. This is a permanent change of CEO, not interim type.  I believe the SVP/executives are recruited, hand-picked and attracted to Jobs to work in Apple.  I observed Tim Cook’s public speech and presence before but not sure he can keep the talents in Apple.  Let’s stay tuned to see anything happens in next few months.

I bought Apple at 330, sold some at 400, and then bought more at 360.  Within next 4 months, I am still optimistic that it can go near 400. I would hold and wait to hear more news next few weeks. Pay attention to any big hedge fund investor trades. See what Cook say and if he can prove himself to replace Jobs in the next Apple event in coming Sept.

Lastly, Jobs’ health condition must turn really bad. Sad to say but I believe this will become a real and permanent departure for him in Apple. I grew up with Mac and PC from 70s, 80s, 90s. Well, technology veterans will compare Jobs to Thomas Edison. WE may lose a great CEO and innovative figure in the world.

I am afraid that I may say Goodbye to Jobs as well as Apple stock very soon.

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I recently read an article by Ben Baden on Yahoo, he talks about the most important 6 indicators every investor should follow.  Of coz, you have to develop your own mosaic of these macro and micro numbers, plus your own due diligence of the companies.  This mosaic will help you feel the inner calling into buying or selling position. Hardly you can find a perfect answer but these 6 numbers are worth reminders for screening purpose.

1. Investor Returns

2. Fund Flows

3. Consumer Sentiment Surveys

4. VIX (option volatility index)

5. Rate of Inflation

6. Interest Rates


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