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I keep getting asked the question “Is China a Bubble?”

And I keep answering “I have no idea, that is not my area of expertise.” But I offer up Andy Xie, no stranger to these pages, as a local expert. And now, let’s add another person to defer to: GMO’s Edward Chancellor.

Barron’s Alan Abelson references Chancellor’s recent piece “China’s Red Flags.”

“Such debacles usually start, Edward has found, with a compelling growth story. Another feature is a blind faith in the competence of the authorities. The ignominious list includes: excessive capital investment; a surge in corruption; easy money; fixed- currency regimes; rampant credit growth; moral hazard; precarious financial structures; and rapidly rising property prices powered by dodgy loans.

Of these, rapid credit growth is the most important leading indicator of financial instability, followed by an asset price bubble. Low interest rates and strong money growth play a significant part, too, in creating memorably bad outcomes. China, unhappily, has its share of these dubious qualities as well as being inflicted by a huge speculative mania.”

Here are the 10 factors that Chancellor flags. They suggest China’s boom will go bust. Each item starts by referencing a specific classic bubble indicator, and follows with the specific China variant (in parens).

China Bubble?

1. Great investment debacles generally start out with a compelling growth story (The China Dream)
2. Blind faith in the competence of the authorities The Communist Party of China We Trust)
3. General increase in investment (Chinese investment Boom)
4. Corruption (rampant in China)
5. Easy money (Money supply grew by nearly 30%, interest rates maintained well below nominal growth rates).
6. Fixed currency regimes (Chinese currency, the renminbi, is pegged to the U.S. dollar)
7. Rampant credit growth (new bank lending increased by nearly RMB 10 trillion, a sum equivalent to 29% of GDP)
8. Moral hazard (China’s leading banks, among the world’s largest by market value, are seen as too big to fail)
9. Precarious financial structures (Chinese banks are particularly reluctant to report problematic loans).
10. Strong credit growth and rapidly rising property prices (a widespread belief that the property prices can only go up)

The entire GMO piece can be found here a nd is well worth some Saturday morning face time . . .

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Sources:
China’s Red Flags
Edward Chancellor
GMO, March 2010
http://bit.ly/9g5yBN

Red Flags Over China
ALAN ABELSON
Barron’s, March 29, 2010
http://online.barrons.com/article/SB126964423756268289.html

Is it just me, or does everything he says now sound like nonsense, given what is now understood about the Maestro:

He is still married to his concept of the market as a perfect forecaster:

From an unnamed investing buddy of Bill Fleckenstein:

A final note regarding the rise of “junk” recently. When “junk” takes off EARLY in a new uptrend, as it did back in April of LAST year, it’s a bullish sign, indicating a revived willingness to assume risk.

HOWEVER, when the junk takes off AFTER a well-recognized up trend, it often suggests slow learners are coming to the party trying to play catch-up. This usually accompanies a big “hot-new-issue” boom and THAT phase ALWAYS marks the end of all bull markets.

We don’t have that “new-issue” fever or a rampant “take-over” fever suggesting a major top but there are plenty of warnings that a correction could hit at any moment and all it would take is some unanticipated “news” event.

I’ve met some Bulldogs and Pits — they are incredibly powerful creatures:

A Chattanooga Police officer, while running radar at 1410 Workman Road on Sunday night, had his patrol car attacked by a ferocious bulldog.

Officer Clayton Holmes said he had stopped to work on a report when he felt his car shaking. He got out to investigate and what he found was a bulldog chewing on his patrol car.

The dog chewed two tires and the entire front bumper off of the car.

In light of our discussion yesterday (More Foreclosures, Please), Jim Fickett of ClearOnMoney sends us these charts:

They are the result of the Mortgage Metrics report for Q4 of 2009, and the results are distressing.

Serious delinquencies continue to rise – in the 64% of the market covered by Mortgage Metrics, there are now about 3.4 million loans either seriously delinquent or in the process of foreclosures. Completed modifications actually declined in each of Q2-Q4 of 2009. (Foreclosures have been flat).

Thus, as this chart suggests, the various programs amount to little more than window dressing hiding the underlying weakness of the Real Estate market

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chart courtesy of Clear On Money

More charts after the jump:

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US stock market returns – what is in store?

Surging stock markets since the lows of March 2009 have caught most investors by surprise, especially as new pieces of the economics puzzle are not always rosy and do not quite seem to support an overly bullish case. In short, investors are increasingly struggling to make sense of the most likely direction of stock prices.

Are we perhaps nearing the end of a cyclical bull phase in a structural bull market? Or will strong earnings growth ensure the longevity of the bull? Or is a “muddle-through” trading range in store? It seems to be a case of so many pundits, so many views.

It is one thing to trade the market’s rallies and corrections, but this is easier said than done, with not many people actually getting it right with any degree of consistency. Others are of the opinion that the recipe for creating wealth is simply to follow the patient approach, saying that “it’s time in the market, not timing the market” that counts. But “buy-and-hold” investors in the S&P 500 Index are still 25.5% down from the levels of 10 years ago, the Dow Jones Industrial Index a similar 23.5% lower and the Nasdaq Composite Index a massive 52.5% under water.

This gives rise to the all-important question: does one’s entry level into the market, i.e. the valuation of the market at the time of investing, make a significant difference to subsequent investment returns?

In an attempt to cast light on this issue, my colleagues at Plexus Asset Management have updated a previous multi-year comparison of the price-earnings (PE) ratios of the S&P 500 Index (as a measure of stock valuations) and the forward real returns (considering total returns, i.e. capital movements plus dividends). The study covered the period from 1871 to March 2010 and used the S&P 500 (and its predecessors prior to 1957). In essence, PEs based on rolling average ten-year earnings were calculated and used together with ten-year forward real returns.

In the first analysis the PEs and the corresponding ten-year forward real returns were grouped in five quintiles (i.e. 20% intervals) (Diagram A.1).

The cheapest quintile had an average PE of 7.7 with an average ten-year forward real return of 11.4% per annum, whereas the most expensive quintile had an average PE of 23.4 with an average ten-year forward real return of only 3.8% per annum.

This analysis clearly shows the strong long-term relationship between real returns and the level of valuation at which the investment was made.

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I love this bit of bracketology from The Consumerist:
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click for bigger graphic

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Hat tip Mike Panzner

As has been hinted at for the past few days, Germany and France have agreed to involve the IMF in a joint backstop that will be there for Greece ONLY if they run into a funding crisis. Greece needs to raise about 20b euro’s by the end of May to meet upcoming maturities. ECB Pres Trichet who said he wanted to avoid using the IMF yesterday, said he was “extraordinarily happy that the government of the euro area found out a workable solution.” Greek debt is rallying, stocks are up 3% and the euro is higher. Greece issues notwithstanding, the stock market the past two days has been stopped in its tracks because of the sharp rise in US interest rates which are falling a touch today. Bankrate.com said the average 30 yr mortgage rate rose to 5.11%, up 11 bps in 2 days and to a one month high. Helped out by the weaker yen, the Nikkei rose to the highest since Oct ’08 and the rest of Asia rallied as they will be more immune to a global rise in rates.

Here is something odd — it feels to me like the collapse of Bear was a decade ago.

It doesn’t seem possible, but this month is only the 2 year anniversary of the 2008 implosion at Bear. A bizarre Wall Street time compression seems to be taking place — it  makes it seem like it was so much longer ago. I experienced a similar chronological dilation the first year after 9/11. Time flowed like molasses.

Its fascinating to look back at what was being written and said then — I dug up a few posts from March 2008 — they are pretty wild stuff:

• Who is to Blame for Bear Stearn’s Demise?

• WTF Headline of the Day: S&P Cuts Bear Stearns’ Rating

• Two Dollars/share, or an “Orderly Liquidation” ?

And of course, the infamous photo from the Bear HQ.

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Did anyone ever find out who posted that ingenious bit of street theater? I’d love to shake his hand . . .

This was all but inevitable:

Bond insurer Ambac Financial Group said again that it may seek bankruptcy protection after state regulators took control of some of its most troubled assets.

The news Thursday sent the company’s already devalued stock into a tailspin.

The Wisconsin insurance commissioner on Wednesday ordered Ambac’s main operating subsidiary, Ambac Assurance Corp., which is based in that state, to set up a segregated account for policies related to risky structured finance transactions. Those include the credit default swaps and residential mortgage-backed securities held by major Wall Street banks that helped to accelerate the national financial crisis.

At one point in time, ABK had the highest income per employee of any publicly traded firm.

Here’s what I previously had written about them:

Like Ambak (ABK), MBIA ran what was an enviably low risk, high return business. They sold a product that was more or less unnecessary — Muni Bond insurance — to willing buyers that saw a decrease in borrowing costs once they bought into the game. I don’t buy into the notion that muni bond insurance is a scam, but it comes close: Fund buyers got insured paper, Muni borrowers got lower rates (therefore saving on borrowing costs), and ABK/MBIA got well paid for insuring bonds that went bust at one of the lowest rates of all classes of fixed income paper.

As we noted back in January, that high profit, low risk situation — despite its enormous profitability — was obviously intolerable. In came the financial engineers, as the thought process seemed to be “Hey, we should be issuing insurance on riskier paper — think about how much much bigger the premiums are than boring old munis!”

The rest, as they say, is history . . .

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Previously:
MBIA DESERVES to Go Belly Up (August 11th, 2008)

Counter-Party Risk (January 18th, 2008)

Source:
Ambac may seek bankruptcy after regulators step in
EILEEN AJ CONNELLY
Reuters,  March 25, 2010
http://www.google.com/hostednews/ap/article/ALeqM5gnFJ45TM0cp0m207GbS3EZdHfucQD9ELUBIO0