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August 19, 2009 | |||||
There is no "official" definition of a bear market. But it's widely accepted that a 20% drop in a major index constitutes one. The Chinese market just crossed that line…Last week, we warned you that China was a bubble looking for a pin. At the time, some air had already leaked. The Shanghai Composite Index was down by 10% from its high on August 4th. Last night, the index briefly dipped below the 20% threshold that marks a bear market. At its recent peak, the S&P 500 was up 50% from the lows in March. But Chinese stocks more than doubled from their lows. After a run like that in a major index, selling seems like a rational idea.But that's not what Shanghai-based money manager, Larry Wan thinks. He oversees about $583 million in assets. Wan says that it is "irrational selling that has shattered market confidence."
What is truly irrational is that the Chinese authorities did not allow the market to liquidate the mistakes of the first bubble.Instead, they pushed a stimulus plan which forced Chinese banks to make loans to state-preferred companies. The bulk of the money has gone into massive construction projects. Many of these projects were completely unnecessary and are now sitting empty. And many of these loans will not be repaid. U.S. politicians embarked on our own emergency stimulus plan. And if you ask the average man on the street, he'll tell you it's not working. That's what USA Today did.A USA Today / Gallup Poll found that 60% of adults believe the stimulus plan won't help the economy in the years ahead. Only 18% believe it has done anything to help their personal situation. IDE analyst Andrew Gordon suffers no such delusions…He notes that companies made it through the second quarter with massive cost cuts. But revenue and earnings growth was a no show. As for "what's next", Andy listed four too-good-to-be-true scenarios...
The past five months have been an earnings multiple rally. Earnings have actually declined during this period. Investors are paying more for companies during a time when the economy shrank 1%.The only explanation is that investors are pricing in a quick economic recovery. If they are wrong, the market will take back much of its recent gains. Andrew believes this rally has been a "huge leap of faith and is completely unsupported by what's going on in the economy." For there to be any sustainable recovery, the housing market must pick up. And we're beginning to see some signs of life.In June, sales of new homes rose by 11%, the biggest increase in eight years. Sales of existing homes increased 3.6%. Building permits are also up. And new home construction rose 2% last month. It was the fifth straight month that this indicator has gone up. New home construction is up 37% from its low this past winter and is expected to help the economy for the first time in over three years. But it's not all roses yet. The industry is off 70% from its high in 2006. And there are several dark areas that will put off a full recovery for quite a while.Sound Profits editor, Steve McDonald, points out that unemployment is still expected to reach 11%. That means more people who can't pay their mortgages. Also, the 10% tax credit for of the cost of a new home (up to $8,000) is due to run out in November. And the real estate market still has a large supply of low-priced foreclosures, which should keep prices suppressed.
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