Dohmen: Beware of China and the BRICs

BRIC is an acronym for Brazil, Russia, India, China. These stock markets have been the most highly promoted of the global markets. Every analyst appearing in the media has them on their “buy” list.

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My rule is: beware of “over-owned” markets! They are always the worst performers when the plug is pulled. During last year’s Euro-crisis, the emerging markets plunged from 30-40 percent. Are you willing to risk that?

Let’s look at India, which is so typical of the other BRICsas well. A recent news article about India stated, “Even after the bank raised interest rates by a record 375 basis points (3.75 percent points) in 1.5 years, wholesale prices have risen more than 9 percent on an annual basis for 12 straight months.”

You see, they believe the old wives tale that raising interest rates reduces inflation . It actually does the opposite, but that is our minority view. Higher interest rates actually boost inflation unless loan creation is tightened aggressively. Brazil has followed the same policy. China was so much smarter. They raised interest rates somewhat, but they tightened credit by hiking bank reserve requirements aggressively. That’s the way to fight inflation, although it’s painful.

India’s real GDP growth (inflation adjusted) is now down from around 10 percent to 6 percent, which is near the crisis low of late 2008. Yes, in an emerging country, 6 percent growth is recession. GDP growth is probably much worse if they would use the higher, true rate of inflation to adjust GDP. The decline in the growth rate is now in its third year. That means that most of the stimulus after the last crisis has been used up. We will see this happening around the world over the next one-two years.

Russia is extremely vulnerable because it is basically an energy economy and so dependent on sales to western Europe. As Europe goes into a deep recession, Russia will follow. A Greek exit from the EU would be disastrous for Russia.

In our China Boom-Bust Analyst I have written about the hidden China crisis for months. One year ago, I wrote a special “Whitepaper”, The Coming China Crisis. It is now intensifying at an accelerating pace, fueled by the collapse in housing and severe decline in export growth. The government is trying to de-emphasize “exports” as the growth engine because it has no control over the decline, and take more measures to grow the consumer part of the economy. But that’s impossible during a recession. Yes, it may shock you, but China is now entering a recession. The “official” GDP growth number is a fairy tale.

According to the Purchasing Managers Index (PMI) from HSBC, China manufacturing has contracted for 10 out of the last 11 months. That refutes the governmentally produced GDP growth number of 8 percent growth. In April, credit growth plunged a horrifying 33 percent. The latest report suggests that China’s economic growth may soon be at a 22 year low. That means the China economy is ready to plunge off of the cliff.

This week the China story was that the government would produce another stimulus program, but much less than the one in 2009. It would include infrastructure, “cash for clunkers”, and all the things that didn’t work in the US over the past three years. The global markets celebrated the news — for one day.

By the next day, analysts apparently read the release of the government’s Xinhua news agency said:

“The Chinese government’s intention is very clear: It will not roll out another massive stimulus plan to seek high economic growth,” Xinhua said today in the seventh paragraph of a Chinese-language article on economic policy, without attributing the information. “The current efforts for stabilizing growth will not repeat the old way of three years ago.”

Yes, you have to read the details. So, the sellers came back in. The gains of the prior day were wiped out.

My view on the China “stimulus” is this: as we know from the US experience, such programs are ineffective. Furthermore, lowering banks’ reserve requirements does nothing when there is no loan demand from creditworthy borrowers. When loan demand plunges, the central bank is helpless in trying to stimulate.

The fact that a “stimulus” program is now deemed necessary in China confirms that the situation is worrisome. My work has shown that China exports are now contracting. That will be the next “shocking” news when the numbers come in. No amount of stimulus can change that because it depends on the buyers, namely Europe and the US.

Another huge problem for all the emerging countries is that foreign direct investment flows (FDI) into the countries lead to economic booms. When the booms are over, the flows reverse and go out. Suddenly, these economies are short of capital. And that’s when the avalanche downward starts. All of the emerging countries are now encountering this, even China.

In the US, the latest economic numbers, such as Durable Orders, suggest big trouble ahead. It’s still the best house in a bad neighborhood, but eventually will go the way of the neighborhood unless there is a big change in November.

Conclusion: Take the headline of this article seriously. The emerging markets always suffer much more because of the low volume. Because so many emerging markets “experts” have remained stubbornly bullish so long, even while all the technical indicators scream “sell,” means that there is a lot of selling to be done. Who will they sell to? These markets are very thin. Of course, for informed traders, this represents a great opportunity — on the short side.

Wishing you enlightened investing,

Bert Dohmen

Bert Dohmen is founder of the Dohmen Capital Research group, editor of the Wellington Letter and China Boom-Bust Analyst and author of "Prelude to Meltdown," "Financial Apocalypse" and "The Coming China Crisis."