Category: Investment

The Chinese Stock Market is a Bubble

China Finance and marketThe figures and stories on China’s stock market keep getting higher and crazier. The Shanghai index is now up over 140% in the past year, while the Shenzhen Index is up 185%! Among the slightly more than 1,700 stocks on the Shenzhen Index, only a mere five have declined this year; and individual stock rallies of more than 500% “are not unusual.”

IPOs in China are so hot that recently a company seeking $2 billion attracted bids totaling $273 billion, virtually equivalent to the entire economic output of Hong Kong. Further, shares of the 144 firms that went public this year have averaged a return of 539% so far.

Valuations are looking frothy as the Shenzhen index now trades at approximately 44 times projected earnings, compared to the Nasdaq’s current 23 and the MSCI World Index of 17. The entire market capitalization of the Shenzhen index is now $4.7 trillion, surpassing the U.K.’s entire stock market value.

What’s driving the index to these nosebleed levels? It doesn’t appear to be fundamentals or an improving Chinese economy; rather, it is individual investors opening new brokerage accounts and trading on margin.

Newly opened brokerage accounts have spiked in recent months, while margin financing (borrowing money to trade) has also gone parabolic. A recent Bloomberg story recounted a 28-year old office worker in northern China who travelled 1,000 miles to set up an account in Hong Kong in order to get cheaper trade commissions and lower margin finance charges saying, “I can make more money if I can borrow more.”

Perhaps Chinese citizens have just gotten stock market fever and are getting caught up in the euphoria. Alternatively, it also appears the Chinese government actually had a direct role in creating this hysteria. Last August the state-run media started urging the Chinese public to put their savings into stocks, “espousing the wisdom and patriotism of owning equities.” The government has also reduced fees and now allows individuals to open 20 accounts instead of only one.

But that begs the next question, namely, why does the government want its citizens in the stock market so bad? According to Anne Stevenson-Yang of J Capital Research, a Beijing-based research group, there are two main reasons. First, a bull market will allow heavily indebted firms, many of them state-owned, to swap out debt for equity which they won’t have to pay back.

The second is to provide an alternative to the sagging Chinese property market. It wasn’t too long ago that Chinese savers and investors were stashing their wealth into empty apartment buildings, trying to earn a return or at least keep their principal safe as they didn’t trust the banking system. But the real estate bull market has run its course and now they are turning to the stock market as an alternative.

This is the unfortunate outcome of a country that continually tries to centrally plan economic growth and inflate its economic statistics. Instead of allowing real wealth producing activities to take place, which is messy and takes time and hard work from entrepreneurs, the Chinese government bounces from inflating one asset to the next in order to juice GDP numbers. Chinese citizens are then forced to play the same game in an attempt to preserve their wealth and earn a return on their money.

Chris Kuiper, CFA is currently a student and researcher at George Mason University pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.

Tax Assessors Go Airborne

drone_tax_assessmentIt’s a plane! It’s a drone! It’s…..the property tax assessor? That’s right, as local governments start to look under the couch cushions for loose change, they have found a more high-tech and lucrative way to garner more tax revenue: use airplanes and high resolution aerial photos to detect property improvements. This method allows them to see improvements such as home additions, extensions, new garages and swimming pools that drive-by inspections could not observe before. They are also more likely to catch those giving false information on their tax assessment forms.

Local governments in the U.S. are now joining other international governments in using aerial and satellite imagery to find more taxable wealth. Already back in 2010 the Greek government was using Google Earth to find unreported swimming pools; they found in the suburbs there were not 324 pools as reported, but actually almost 17,000! The Irish Tax Commissioners also followed suit. Then in 2013, The Daily Mail reported that Officials at Her Majesty’s Revenue and Customs were using Google Earth and Google Streetview to find fancy cars, home additions and new construction in the UK to try to decide whether to investigate homeowners they suspected of paying too little tax. They even reported that tax officials would add extra details to their searches such as people bragging on Facebook about a new car or exotic vacation. The Long Island community of Riverhead also used Google Earth to find pools that were constructed without filling out the proper paperwork or paying the permit fees, bringing the town over $75,000 in fees.

It shouldn’t be surprising that even governments will eventually adopt the latest technology if it means more revenue for them. What is interesting is how these stories illustrate an embedded disadvantage to holding wealth in the form of real estate. Real estate, unlike other assets such as precious metals, almost always carry a real estate tax which is usually assessed annually based on its estimated value. So even if you fully own a piece of property or land, there will still be an annual cost to holding it. Further, if the perceived value of the land goes up, the tax will likely go up as well. Precious metals, held outright, do not have such a tax. Currently the only possible tax would be on the gain realized after selling it; but at least as the value of the metal appreciates, there is no annual tax also increasing.

The other variable with real estate is how the real estate tax or anticipated real estate tax can affect the property’s value. If it is believed real estate taxes are expected to increase significantly in an area, the value of the property will likely decline compared to other areas where the real estate tax is not expected to be as high. An interesting example of this we may see in the coming years could be in Chicago which has expected pension payments to spike in 2016. It is estimated that to fully fund these pension payments, Chicago would have to increase homeowner property taxes by approximately 50%! This isn’t to say real estate will not remain a good option for holding wealth, but it is important to note some of the advantages and disadvantages of location and other factors when comparing alternatives.

Chris Kuiper, CFA is currently a student and researcher at George Mason University pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.

Where is the Inflation?

Money_falling_from_sky_inflationLegendary investor Warren Buffett recently admitted that he was wrong on interest rates, noting at the Berkshire Hathaway annual shareholders meeting, “It is so hard for me to believe that you can drop money from a helicopter and not have inflation, but we haven’t.” Many like Mr. Buffet are wondering the same thing. After dire predictions of the coming inflationary tsunami from sound money advocates, where is inflation?

When most people talk about inflation, they mean a general rise in the level of prices, usually measured by the CPI. After bouncing between 1-2% for the last few years, the CPI has recently made a dramatic downturn and has even posted a small negative year-over-year rate for March. But as many of our readers know, the true definition of inflation is literally inflating the money supply – the general rise in prices is merely a symptom or consequence of this.

Using this definition, we see that the money supply is indeed being inflated by a number of measures. The M1 money supply (cash and checking) continues its march upward, still growing around 10% per year; M2 (M1 plus savings deposits) shows similar constant growth, but growing around 6% per year. But if we have established that the money supply is growing, why haven’t general consumer prices risen?

If consumers did receive a “helicopter drop” of money in their front yard, we probably would see an almost immediate increase in prices as they would go out and bid up goods and services with their new money. But the growth in the money supply we have seen is done through a different channel. When the Fed engages in things like QE, it doesn’t send regular citizens a check in the mail; rather, it buys government bonds and lowers interest rates.

So if newly created money is going to financial assets, we would expect to see increases in those assets as well as interest-ratePicasso_inflation sensitive assets, not in the prices of consumer goods and services that the CPI measures. Not surprisingly, this is exactly what we find. Publically traded stock valuations are at all time highs, private company valuations are ballooning, and bonds yields are at record lows with forty-five percent of the world’s government bonds yielding less than one-percent, and many even showing negative yields (which means their prices are at record highs.) When he was chairman, Bernanke noted that higher stock prices will create a “wealth effect” as consumers will be wealthier, helping to increase confidence and therefore spending. Unfortunately, only fifty-five percent of Americans own stocks. As stocks and bond valuations get frothy for the wealthy, we would then expect money to start flowing into other assets to preserve wealth. Art is one example of this, which has recently been on a tear; this past week a Picasso sold for $179 million, a new world record. Real estate is also seeing a boom and price surge in the ultra-luxury markets.

So to see where the inflation is, one only needs to look at where the newly created money is going. Yes, general consumer prices aren’t running away (except for healthcare and tuition expenses, but that’s another topic); however, prices of assets that are affected by QE and low interest rates certainly are. Remember, the CPI didn’t go to the moon during the last housing bubble either, staying around 3% even though house prices and the stock market were bid up.

Finally, it is also helpful to remember the true definition of inflation because today’s definition can mask a lot of small but constant inflation. For example, if entrepreneurs can find a way to deliver a product to consumers for five percent less than the current price, the consumer benefits. Yet if inflation causes the price to increase back to its former price, the CPI will register 0% inflation, yet there is indeed a loss of purchasing power here.

Keeping the true definition of inflation in mind reminds us how and why asset bubbles can form and also why inflation will continue to erode standards of living and the need for personal wealth preservation.

Chris Kuiper, CFA is currently a student and researcher at George Mason University pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.

Swiss Bank Refuses Large Cash Withdrawal

Swiss BankSwiss Bank Baulks

Swiss banks used to be world-renowned. The nation has had a reputation for banking secrecy and international neutrality, making it a relatively safe place to store wealth. Unfortunately, the costs of Swiss banking might soon outweigh those benefits. As negative interest rates continue to permeate the Swiss economy, at least one bank has declined a customer’s request for a large cash withdrawal. This probably occurred at the direction of the Swiss National Bank (SNB).

The negative interest rates took effect at the central bank in January 2015 amidst a failing Russian economy and crashing oil prices. Private lenders have been forced to follow suit. Instead of paying interest on deposits, some now charge customers for the use of their money. This has been a huge blow to the fiscally responsible Swiss. Those with retirement funds and similar investments are now losing money by keeping it in the bank.

Further problems arose when one pension fund manager tried to avoid those losses. He wanted to withdraw his fund’s money from the bank and move it to a separate storage facility. That would save his clients 25,000 Swiss francs per year for every 10 million francs in the fund. Storing cash in an insured vault would still cost money, but it would be far cheaper than keeping it in the bank.

Withdrawal Request Denied

WithdrawalSomewhat unexpectedly, however, the bank denied this request and provided little explanation for the decision. A letter to the fund manager simply stated that his expectations could not be met within the specified time period. Many have speculated that the bank’s actions were spurred by a directive from the SNB. The central bankers might feel that large withdrawals could lead to a cash shortage and cause banks to fail. If that happened, Europe could face an even more serious economic crisis.

At least one banking expert has suggested that the bank’s refusal was clearly illegal. Even if the SNB did issue a directive, it should not have superseded the law. The fund manager’s contract dictated that he should have been allowed to withdraw his money at any time and the private bank should have been legally obliged to honor that request.

In the financial sphere, there are all kinds of deposits, and some do take time to mature, but the pension fund’s account was not like that. It was known as a sight deposit account. The SNB itself defines sight deposits as “Funds which can be transferred immediately and without restriction to another account or which can be converted into cash.” Based on that definition, the bank should not have been allowed to withhold the pension fund’s cash.

Distressing News

Financial FreedomThis news is so distressing to many because Switzerland is supposed to be one of the world’s most economically free countries. (Switzerland is ranked at number 5 and the United States is number 12.) If the Swiss government can start restricting withdrawals on a whim, how much worse could things end up in countries that are less free? This might be an important sign that the global economy is still precarious and securing wealth in trusted, physical assets is essential.

Daniel Brown is the editor-in-chief of You, Me, and BTC. He’s also the “Everything Elf” at