China bubble to burst, Greenspan predicts

Former U.S. Federal Reserve Chairman Alan Greenspan warned Wednesday that there's going to be a "dramatic contraction" in Chinese equities and that the current surge on the Chinese stock market is unsustainable, according to media reports. In recent weeks, a number of financial firms, including Goldman Sachs, as well as Governor Zhou Xiaochuan of the People's Bank of China have expressed concern about the possibility of a bubble forming in the Chinese stock market. The Shanghai Composite Index, which tracks shares listed on the larger of China's two stock exchanges, has gained 56% year-to-date.

Is there anyone who doesn't think the Chinese markets are bubblicious?
The bigger questions are whether or not Chinese policymakers have lost control of the economy.

OK, that was written last May...for anyone owning anything in China they have seen remarkable appreciation.

Yesterday, Buffett continued on as was reported by Bloomberg News:

Former Federal Reserve Chairman Alan Greenspan said China's stock market is a speculative bubble that will burst.Asked if China was in a state of "irrational exuberance," a phrase Greenspan made famous in 1996, he said, "I think so," speaking to a conference of insurance executives in Boston on Tuesday."When you don't expect it, it breaks," Greenspan said of the bubble.

His comments reprise remarks from May, when Greenspan said he was concerned Chinese equities might undergo a "dramatic contraction" after its main stock index at the time had jumped more than 90 percent since the start of the year.Greenspan's latest words of concern come at a time when investors are increasing bets on Chinese equities. Tuesday, PetroChina Co. and Alibaba.com Ltd. sold stock valued at more than $10 billion.

PetroChina, the world's second-largest company by market value, raised $8.9 billion in the biggest stock sale this year.Alibaba, the operator of China's largest trading Web site for companies, sold $1.5 billion of shares in the second-biggest initial public offering of an Internet company, after Google Inc., said two people with knowledge of the matter.China's benchmark CSI 300 index has surged 170 percent this year as the country's households invest more of their $2.3 trillion of savings in equities. The rally has given China more of the world's 10 largest companies than the U.S. for the first time and prompted billionaire investor Warren Buffett to warn that prices have risen too fast.China's stock market value is $3.7 trillion, compared with $18.7 trillion for the U.S."It's easy to be carried away in the stock market when things are going very well," Buffett said Oct. 24. "We at Berkshire never buy stocks when we see prices soaring."Greenspan on Tuesday also predicted a "long-term erosion" of the dollar in part because of the U.S. current-account deficit. The U.S. currency's decline is accelerating, he said.For three years, Greenspan has said the dollar will weaken when international investors tire of financing the U.S. current-account gap, the broadest measure of trade."We are likely to see a long-term erosion of the dollar," said Greenspan, 81, who retired from the central bank in January 2006 after 18 years as chairman and last month published a memoir titled "The Age of Turbulence."

How a Fed rate cut raises oil prices

Expect even higher crude prices if the central bank cuts interest rates Wednesday.

If you think oil price are high now, wait till Wednesday.That's when the Federal Reserve is set to announce its decision on interest rates. Most say a cut is coming. If the Fed cuts rates, it will probably push oil prices higher.

There are a couple of reasons lower interest rates usually cause higher oil prices. The first is lower interest rates are designed to spur economic growth by making money for investment cheaper to borrow. Stronger economic growth usually entails using more energy, so traders bid up oil prices on the expectation of higher demand.

Second, lower interest rates usually cause the dollar to fall, as they make dollar-denominated investments like Treasurys less attractive for foreign investors.

Oil, like many other commodities, is priced in dollars worldwide. If the dollar falls, oil producing nations, like those in OPEC, need a higher price per barrel to maintain a the same level of revenue. While oil producing countries don't set the price of oil in the market, they do have control over production and are less likely to increase it when faced with the declining dollar. Also, foreign consumers have less incentive to reduce demand if oil is, relatively, getting cheaper for them.

The real question is this: Is a rate cut already priced into the cost of a barrel and, if not, how much higher is crude expected to go?

"Some has been priced in, but we could see more," said Mike Stelmaki, energy analyst. "I think a couple of bucks is possible."

That would push crude prices, already at record nominal levels, to somewhere near $95 a barrel. That's just shy of the all-time inflation adjusted level of between $93 and $101 a barrel (depending on which calculation is used) set in early 1980s during the Iran-Iraq war.

Mike didn't say how much higher oil could go, but also suggested a rate cut hasn't been fully priced in.

"The temptation is to say it must be priced in, but it could still go higher," he said.

He also noted that a deeper rate cut from the Fed, like half a percentage point, would cause prices to jump further.

According to futures listed on the Chicago Board of Trade, investors say there's an 86 percent chance the Fed will cut its federal funds rate by a quarter percentage point to 4.5 percent. The funds rate is an overnight bank lending rate that influences how much interest business pay for capital loans and consumers pay for things like auto, credit card and home equity lines of credit.

Investors say there is a 14 percent chance the Fed will cut rates by half a percentage point, according to futures on CBOT.

The falling dollar is a fairly prominent reason oil prices are moving higher, as "fundamentally, there really haven't been that many things to cause this price rise."

But others say the dollar's role has been exaggerated.

We didn't expect to see much of a price jump if the Fed cuts rates, and attribute oil's recent record run to rising worldwide demand running up against limited supplies.

Buffett: Expect more subprime pain

Billionaire investor sees problems in the subprime market affecting consumers for up to 2 years, but expresses confidence in U.S. economy.

American billionaire investor Warren Buffett said Thursday that problems in the U.S. subprime mortgage market will likely weigh on consumers for up to two years, but that the U.S. economy will weather the storm.

The subprime problem "is having an impact," Buffett said on his first visit to South Korea. "It will have more of an impact."

Billionaire investor Warren Buffett

Rising default rates among U.S. mortgage holders with poor credit histories have rattled globalcredit, stock and currency markets since August and raised concerns about a possiblerecessionin the U.S. economy, a major export market for Asian companies.

"In the next 6 months, one year, two years the problems in the mortgage market can cause a lot of problems with consumers and hurt buying power in the United States," he said at a press conference after arriving earlier in the day from China on his private jet.

However, the U.S. economy has often had to face various difficulties and the present was no exception, Buffett said.

"Overall the economy will make progress," he said.

Buffett came to Daegu, located about 180 miles southwest of Seoul, to inspect Iscar Korea, a subsidiary of Iscar, the Israeli industrial tool manufacturer that his company, Berkshire Hathaway Inc., purchased last year for $4 billion, its first overseas acquisition.

Buffett also expressed pessimism on the U.S. dollar.

"We still are negative on the dollar relative to most major currencies," he said.

The dollar has fallen against the euro, British pound, Japanese yen, Indian rupee and many other Asian and European currencies this year. The euro, for example, has gained 8 percent against the dollar this year.

Roller Coaster Rides

Roller Coasters take you way up high and then drop down dramatically...up and down and up and down. Then at the end of the ride...you are right back where you started. Hmmmm.

Apparently, no one wants to be short or not long enough headed into another rate cut even amid the bad news out there. After selling off this morning and following a feeble rebound effort, a rumor that the Fed is going to do an emergency rate cut sent the shorts running.

There have been some wild moves over the past week and its been difficult to explain it. Pure manipulation? Perhaps. But no matter what it is, it makes for a difficult time unless you're renting stocks for just a few seconds. We know as we watched the tape reverse course this afternoon. Something strange is going on other than just mere speculation on the Fed's next move. No matter what you think of the economy, the next week or so is going to be an interesting time for the markets and we're not just talking about the continuation of earnings season. Make sure you have your seat belts fastened.

1987 Crash Revisited

Rob Fraim puts out his own amusing comments each day via email. On the 17th anniversary of the 1987 stock market crash, he put out his recollections from that day, and we are republishing them today, the 20th anniversary of Black Monday.

Here is Rob's version of 1987 Crash Revisited. If nothing else please take a look at the charts below.

October 19 – the day that each year gives old-timers in this business a renewed facial tic and post-trauma flashbacks.

“What?” you say. “You mean you were actually there, Grandpa? You remember the Crash of ’87?”

Yes, I was, and yes I do. Confirming rumors that I am, in fact, older than dirt I note that I was in this business in 1987 – and had been for a few years prior (I started in 1983.)

I was having dinner last week with a friend who runs a hedge fund (another graybeard, although he looks younger than me) and we ended up talking about 1987. He had a great story about the whole thing (which I’ll let him tell you about someday if you ever get to have dinner with him.)

So I thought I would take a moment to reflect on my own Crash Experience – and perhaps some of you will share your October 19, 1987 story (provided you’re not a whippersnapper who would be relating what was on freakin’ Sesame Street that day! I really hate you guys. You’re svelte and unwrinkled and smart and energetic and I’m just liable to whup you if you’re not careful.) Maybe we’ll even get a recounting of the aforementioned dinner tale from last week. So if you feel like it, drop me a note with your recollections. If I get enough to make it worthwhile, perhaps I’ll compile them for sharing.)

“What I Did During the War (or What Felt Like One Anway)” or…

“Dr. Strange-Broker or How I Learned to Stop Worrying and Love the Bear” by Rob Fraim

I was 29 years old, 4 years in the business, with two young children. I thought I had investing figured out, didn’t really, and was working for the old Dean Witter (now Morgan Stanley.) The market had been mostly good during my relatively brief time in the business and I had survived the crucial new-guy starvation years and had built up a fairly good book.

So good in fact that I listened to my manager – an advocate it turns out of the “if-you-get-the-brokers-to-really-get-themselves-in-hock-they’ll-be-
forced-to-produce-more-just-to-pay-their-bills” school of thought. (He was also the genius who kept telling us to forget about analyzing stocks ourselves. “Look, we pay those analysts in New York a lot of money to do that. Do you think you know more than those guys? Your job is to sell.” He is no longer in the business, by the way. Last I heard he had left his wife and family and was involved in a relationship with a New Age guru type who had helped him to discover his true “orientation.” He’s raising llamas with this guy and chanting or something. But I digress.”

“You need a new house” he said. “That “piece of#%@ little house of yours isn’t enough. You need to aim higher. Think bigger.” Actually a new house seemed like a pretty good idea, and the kids were getting bigger, and business was good, and hey…what’s a little extra mortgage to a hot-shot like me?

I pasted a picture of a big house on the door of my little office (thanks to the suggestion of my motivational coach in the big office) and embarked on the quest to get me some o’ that.

Before too long I was closing on a house that was twice the size of the old one and came complete with a mortgage that was only 3 times as large. Coolio!

We closed on the house on October 1, 1987.

Oh sure, the market had been a little funky. After peaking in the summer, the market had gone through a pretty good decline – from about 2700 to 2300 or so. In percentage terms, not an insignificant sell-off. But of course it was just: summertime doldrums, a little readjustment, things a little ahead of themselves, no problem, secular bull market, great buying opportunity, hey just look -- now we’re getting a second chance at bargain prices.

And don’t forget: “We’re paying those guys in New York a lot of money.”

On Friday October 16, three of us brokers decided to play hooky and “have meetings scheduled” that afternoon. It was one gorgeous fall day. (By the way, for those of you in other locales – particularly you concrete jungle folks – I heartily recommend my neck of the woods in mid-October. The lower Shenandoah Valley of Virginia – smack in the middle of the Blue Ridge Mountains – is a great place to be when the air turns crisp and the trees put on their autumn show. Drop in sometime. I’ll buy you a beer.)

Making the turn after the 9th hole we stopped in the clubhouse to use the pay phone and call the office (pre-cell phone days you youngsters) and my buddy came back looking a little stunned. “Down 90,” he said. Of course these days 90 points doesn’t mean that much. But down 90 from 2300 was a drop. “It’s over” he went on. “The party’s over.”

The weekend was a little tense, since we knew that Monday would open weak. An understatement as it turned out. The combination of a Treasury Secretary with a big mouth and what was called “portfolio insurance” (which somehow involved the commandeering of the free market system by that crazed computer from “2001 – A Space Odyssey” ) came together in an incredibly imperfect storm.

At some point during the day a strange, battlefield-giddiness sort of took over and we just…all….laughed. It was so surreal that all you could do was just laugh. Mortar shell…giggle…another bomb…chuckle. As the day went on, clients were trying to make moves – a lot of panic selling of course, along with more buying interest than you might imagine. There was one small problem though – the systems just crashed. Market orders, limit orders, stop orders – all in, but no reports.

“Are we filled?”
“Don’t know.”
“Should we re-enter the order?”
“Don’t know – it could have failed and you need to re-enter, or you could be duping a trade.”
“When will we get reports?”
“Any minute now.”

As it turned out it was days later in some cases – and a nonsensical mix of nothing dones, good trades, and fills that were two points or five points away from where you figured they should be. As the day went on and we approached down 500 we were really trying to do some buying. But there was no way to know what, when, if, and at what price trades were filling.

In a strange little wrinkle, I figured out something about the Dean Witter system that day. Back then there was an odd-lot order execution system at Dean Witter. If you put in an order for less than 100 shares close to the limit where it was trading, the system would automatically fill it (internally, not actually on the exchange) and then almost simultaneously fill it on the exchange so that the system was flat on the position. By chance, one of the orders that I put in during the period where executions weren’t being reported was for 70 shares of something or another. Boom. Instant fill. So the next order for 400 shares or whatever it was – went in as 99-99-99-and-3. Boom, boom, boom, boom. I became king of the odd lots for about a day until they wised up and shut the auto-fill system down.

On Monday night, the manager made an evening shift mandatory.

“Call your clients. Tell them what’s going on and what to do.”
“Uhhh….what is going on and what should they do?”
“

…..I don’t know. Tell ‘em to buy or sell something.”

His other fabulous idea was to call lots of people that weren’t clients of the firm and act like we had told everybody to get out before the crash and then talk them into transferring their accounts. Oh he was prince of a guy all right. I hope he and Serge and the llamas are happy.

That was October 19, 1987. I went home late and stared at all of my new walls. I had a lot more of them than just a few weeks earlier. And the first (tripled) mortgage payment was due on November the 1st.

In the days after the October 19 crash things did stabilize a bit – even rallying some. Corporations stepped in with real buybacks (not the maybe-someday ones we see so often now.) The Fed flooded the system with liquidity and somebody unplugged the hell-spawned computers. The trading systems got back to working and we commenced to explaining why market orders (and limits, and stops) never filled – and more importantly we had the opportunity in the cooler non-panic moments to actually make recommendations and help people figure out how to proceed. “And of course you bought everything in sight since it was the buying opportunity of a lifetime, right Grandpa Rob?” Well, yeah, we did some good buying to be sure. But hand-over-fist-with-reckless-abandon-because-we-knew-for-sure? Well, I wish we had been that smart. But by the time the systems came back in full function we had rallied a couple of hundred and it was awfully hard to find anyone who wasn’t warning of the Impending Great Other Shoe. So yes, we bought, and bought strong, but not as much as hindsight would dictate.

And what most people forget is that the market made its low, not on October 19, but a couple of months later in December. It’s always simple looking backwards, but tougher at the time (as it was in the 1989 United Airlines-related mini-crash, the Persian Gulf war, the 1994 baby bear, the Long-Term Capital mess, the Russian crisis, post-9/11, etc. Or today for that matter.

At the risk of being called a Pollyanna or a head-in-the-sand type, here’s an interesting little exercise. (And you folks know me, and you know my reasonably cautious market stance at present. I have a long bias and am fairly constructive on the market, but my present “play some defense” mode is well documented. And I’m old and feeble and decrepit, so I’m not a reckless sort anymore.)

But take a look at this chart. Pick out 1987 -- The Great Crash of our generation. And then 1989 (or 1994 or…)

Oh…you needed some dates (and a microscope) to help you find them?

Kind of interesting to look at things from a longer-term perspective sometimes huh?

Anyway kids, that was a day in the life of Young Rob, semi-new broker in 1987.

How about you? Care to share your Crash Day story? (Use the comments below to post . . .)

I’ve gotta run now. Business is pretty good. And I have a meeting with my real estate agent about this house I’ve got my eye on.

The smart guys in New York say it’s all good. And never forget: we pay them a lot of money.

by Rob Fraim

Rob is a broker and consultant with Mid-Atlantic Securities, Inc. -- serving the investment needs of institutions and high-net worth individual clients nationwide. A 21-year veteran in the investment industry, he lives and works in Roanoke, VA.

Bernanke: Not The Bottom Yet

Comments from the Federal Reserve chairman, soaring oil prices, and earnings from some major companies were all having negative impact on Wall Street Tuesday.

Speaking in New York Monday evening, Fed Chairman Ben Bernanke said he has been pleased with the impact of the Fed’s Sept. 18 rate cuts, but he cautioned that the struggling U.S. housing market has not reached bottom yet and will be a significant drag on the economy into 2008.

Other than Bernanke’s remarks, soaring oil prices were the big story on Monday. As crude soared to new highs above $86 per barrel, there appears to be confusion in the market as to how much of an impact the rising cost of oil is having on the U.S. economy. Speculation that $100 crude may be around the corner has been rampant.

Oil companies such as Exxon Mobil have been rising on the news, but transportation stocks had been falling. Airlines were one industry that has been hurt by the rising price of oil.

In one speech he makes more than he made in a year

Greenspan sees slowing economic growth

Former Federal Reserve chairman sees strong third quarter, says home prices will fall and economic growth will continue to slow through the beginning of 2008.

While U.S. economic data look good in the third quarter, the growth rate will continue to slow and the housing market will weaken further, former U.S. Federal Reserve chairman Alan Greenspan said Wednesday.

Economic growth should continue to slow through the rest of the year and into the first quarter of 2008, while home prices have further to drop, Greenspan said, speaking before attendees at the World Business Forum, held Wednesday and Thursday at Radio City Music Hall in New York.

"The critical question is the price level of homes in the United States, which are almost certainly going to fall," Greenspan said, as the hefty inventory of unsold homes continues to drive down prices. "What we don't know at this stage is whether, in fact, the decline in home prices will be a large one or a modest one," he said.

Given the current climate, the odds that the United States will skirt a recession now look better than 50/50, Greenspan said. In March, he put the odds of a recession over the next six to nine months at one-third, but that could be offset by stock market prices if they continue to rise, he said.

Greenspan also addressed the credit crisis that roiled markets this summer, noting that credit market adjustments were "an accident waiting to happen" given the low level of credit spreads for such a long period of time.

"History always suggests that that does not last," Greenspan said. "If it wasn't subprime, it would have been something else."

The United States came into the credit crisis amid a "fairly strong" global economic upswing, and talking about the U.S. economy without the worldwide context is "no longer relevant," he said.

Turning to China, Greenspan said growth there has been "quite remarkable," adding that "nobody is fully cognizant or understands why they have done so well for so long." China has moved dramatically toward capitalism, he said, and even though its economy appears to be "overheating," the country continues to progress.

Greenspan also said rising Chinese inflation was of little significance, noting that much of the increase was due to rising food prices.

But, he added, "at some point, they've got to slow down" and other areas of eastern Asia could begin to successfully compete with the country. At least through the Olympics, however, China "should do very well," he said.

More On The Fed And Interest Rates

I think it speaks for itself. A lot of commentary suggests the Fed in the Sep 18 meeting left the door "wide open" for more rate cuts, which I suppose is accurate but for the full context read the Fed minutes yourself. The concluding paragraph reads:


The Committee agreed that the statement to be released after the meeting should indicate that the outlook for economic growth had shifted appreciably since the Committee's last regular meeting but that the 50 basis point easing in policy should help to promote moderate growth over time. They also agreed that the inflation situation seemed to have improved slightly and judged that it was no longer appropriate to indicate that a sustained moderation in inflation pressures had yet to be shown. Nonetheless, all agreed that some inflation risks remained and that the statement should indicate that the Committee would continue to monitor inflation developments carefully. Given the heightened uncertainty about the economic outlook, the Committee decided to refrain from providing an explicit assessment of the balance of risks, as such a characterization could give the mistaken impression that the Committee was more certain about the economic outlook than was in fact the case. Future actions would depend on how economic prospects were affected by evolving market developments and by other factors.

Justices To Hear High-Profile Investor Lawsuit Case

With the Supreme Court back in session, Wall Street is looking with anticipation to a controversial case the justices will hear on Tuesday that could decide how far shareholders can go in seeking damages after being defrauded by companies.

At issue is "scheme liability," which would allow shareholders to sue third parties like investment banks, accountants and lawyers who helped companies deceive investors. A ruling in shareholders' favor by the Supreme Court could open the door for more such suits -- something banks and others would like to avoid.

This is one of the most important securities-related decisions that the Supreme Court will have handed down in a very long time. If it were to go the way of the petitioners you'd see a substantial increase in the amount of securities litigation.

The case -- Stoneridge Investment Partners v. Scientific-Atlanta Inc. -- has split the Bush administration and is the subject of intense political and industry-group interest. It also follows a spate of pro-business decisions from the high court.Moreover, the outcome of the case could affect a separate case pending at the court involving Enron shareholders' claims against big Wall Street banks. Those banks would basically be off the hook if the court rules in the defendants' favor in the Stoneridge case

The White House sided with investment banks and other parties in a brief in the Stoneridge case last summer, going against an argument from the Securities and Exchange Commission that shareholders should be allowed to sue third parties. Meanwhile, groups including the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association have urged the high court to toss the case out, arguing that a victory for the plaintiffs would weaken U.S. competitiveness and jack up companies' litigation costs.

Top Democrats like Senate Banking Committee Chairman Christopher Dodd of Connecticut and House Financial Services Committee Chairman Barney Frank of Massachusetts have argued that plaintiffs should have the right to seek compensation from the third parties.

A ruling against the plaintiffs would continue a string of disappointments for investors.

In June, the justices ruled 8-1 that class action plaintiffs be required to show convincing evidence of fraud before initiating a lawsuit against a corporation. The case was Tellabs v. Makor Issues and Rights. Also in June, the high court sided with Wall Street banks in a case involving investors' ability to sue them for alleged antitrust behavior during the dot-com bubble of the 1990s. Investors alleged that banks including Credit Suisse Group manipulated initial public offerings of tech companies. Plaintiffs objected to the way banks shared information during the offering periods and said that they broke antitrust law. Justices disagreed, saying in a 7-1 ruling that allowing such suits would threaten the efficient functioning of the securities market.

A decision in the Stoneridge case is expected by the end of the year or early next year.

China in Perspective

Here are some facts found in the Economist that help put China in perspective.

For “several years”, emerging markets have been contributing to global growth more than the USA. So what we are seeing unfold in 2007 is really nothing new.
This year, China will end up being responsible for more of global GDP growth than the USA – for the first time ever.

The American consumer may be 4x the size of the Indian and Chinese consumer put together, but so far this year they have contributed more to global GDP growth than the former has.
How vulnerable are China and India to a US consumer slowdown? Some, perhaps (article suggests that every 1% slowing in US consumer spending results in as much as a 0.5% loss to China’s real GDP growth). But China and most Asian countries now export more to the EU than they do to the USA. And over the past year, China’s exports to the USA have only run at +14%; and to the Eurozone that comparable is closer to 40%.

Many Asian governments are running balanced budgets and as a result will have leeway to stimulate fiscally if need be. China, for example, has just an 18% public sector debt-to-GDP ratio, versus 75% in the industrialized world.

As long as Asian growth remains intact, look for commodity prices to remain firm. After all, emerging Asia accounted fully for two-thirds of the rise in world energy consumption over the past five years.

Exports to account for 40% of China’s GDP, but domestic demand is also so solid that without the foreign trade sector, China’s real GDP would still be 9% so far this year (as opposed to the actual +11.9%).

The Chinese stock market has not entered a bubble … yet, anyway (definition of a bubble is a stock I don’t own). Even though share prices have surged 400% in two years, the trailing P/E is 50x and the forward on '08 estimates is around 30x. P/Es in other classic bubbles like Japan and the NASDAQ breached 100x. The market cap is 35% of GDP compared with 180% in the USA at the 2000 peak. Equities represent 20% of Chinese financial assets versus a 50% share in the USA.

The article downplays inflation risk in China: almost all the inflation is in food; excluding food, inflation is running at +0.9%. To be sure, food is one-third of the price index, but at least the data suggest that the inflation is mostly supply-side led, not demand led. The Economist article takes issue with the labor cost issue -- while wages are up 15% in the past year, unit labor costs apparently are still going down due to still-robust productivity gains.