NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.
Among the posts this past week were items on Chicago Fed data and on China's economy.
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Parsing the Economic Data
Originally published on Thursday, May 22, at 9:33 a.m. EDT.
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While this reading is clearly disappointing, there are a few mitigating factors:
- The NAI tends to be fairly volatile month to month, but the three-month moving average showed improvement in April.
- This index is often heavily revised, as at the time of first estimate only 49 of the 85 data points used in this reading are official.
- Other data from April on both production and consumption have shown a stronger economy than this number would suggest.
- The diffusion index within this report showed a reasonably stable reading.
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In mid-May I initiated a buy in the iShares China Large-Cap ETF (FXI), and I have been doing research on several possible individual China longs. The sectors within the Chinese market I am looking to buy are services, e-commerce, automation and mid-level manufacturing. As is very well known, the Chinese stock market has performed poorly both in a relative and an absolute sense over the past five years. P/E multiples are low.
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Here is a chart that depicts the large difference in the performance of FXI compared with the S&P 500. There is no reason to rehash the multiple reasons for the weak performance of China's stock market (e.g., slowing domestic economic growth, a property bubble, opaque reporting/accounting). I have taken a long position in this FXI contrarian play based on the following 10 observations and conclusions.
- The main risk to China's stock market and economy is a weakening property complex that leads to a 10% (or more) decline in construction activity, which will adversely affect related commodities, the industrial complex and local government finances, serving to lower real GDP by 2% (or more).
- China's property downturn may be more manageable than the consensus believes. The valued economists I speak to are looking for more balanced economic growth of 7.2% real GDP in 2014 and about 6.7% next year.
- The probability of a property downturn that leads to real GDP declining to 5% or less (in 2015) is likely only about one in five (20%).
- Despite general concerns, most indicators of the state of housing (prices/activity) in Tier 1 cities are fairly stable, but fears of Tier 3 cities' inventory-to-sales ratios have risen and have to be monitored.
- An important positive relating to housing is that the Chinese household sector is not particularly leveraged as most Chinese consumers are using their homes as a vehicle for savings, given the better-than-10% wage growth trends and a favorable taxation of property income in China.
- The threat of a financial crisis in China might be overplayed given the high degree of liquidity. Nonperforming loans in the banking industry are only about 1%. In the public sector, the Chinese government is capable of issuing bonds to battle any liquidity problems at that level.
- China's labor market has a lot of slack, even though stated unemployment is low, as nearly one quarter of the employed are in the agriculture market. These employed can be transferred into other sectors. Moreover, productivity is still low, leaving room for improvement and sustained economic growth.
- China's political leaders will not allow too much of a slowdown, as they fear social unrest. Property market weakness can be buoyed by easing credit.
- Political corruption is slowly receding, serving to reduce business costs and improve profitability. Until recently, companies had no discipline on expenses with unlimited spending on corporate boondoggles and gift giving.
- PBOC is lowering interest rates, doing unsterilized intervention and is comfortable with the current value of the country's currency.
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