The Asian and European Fronts

Not to trivialize World War II, but there seems to be a lot of things going on across both oceans these days for different reasons.  Different economic fronts and issues have arisen in both China and Greece.  It’s important as always to dig below the headlines and understand what underlies the issues.  Often,  you realize that the issues are the same as they ever were and the uncertainty they create is the worst part.

China Equity Market Slide

We will begin with China, as it has a far greater impact on the overall world economy.  It is important to understand is to disconnect the equity market with the economy.  The Shanghai composite is down at the time of this writing (July 8, 2015) more than 32 percent since its high on June 12.  On June 12^th buy atarax australia. chinese cucumber has been used to treat invasive moles. buy lida daidaihua australia category assigned b xyzal vs atarax pregnancy … , the index was up more than 70 percent above its level from just a year prior.

The recent Chinese stock boom has occurred as the Chinese economy has actually slowed over the course of that same time.  Chinese GDP grew at a 7.0 percent annualized pace in the first quarter of 2015, slowing from the 7.4 percent pace in 2014.

So why the huge increase in Chinese stock prices over the last year?  Ironically, it coincided with the Chinese government relaxing margin requirements over the past five years.  They still require a 2-to-1 margin requirement (essentially you can only borrow 50 percent of the value of the stock you own) and have restricted the stocks you can buy on margin to prevent excessive speculation.  However, there are concerns that many are finding creative ways to get more leverage using wealth management products (WMPs) that act like leveraged stock market bonds sold by some banks in mainland China.

The government cracked down and raised cash requirements to trade on margin in January.  They also restricted the use of WMPs in April and finally limited margin lending by brokers in June, panic selling has ensued.  This has caused many margin calls and panic by individual investors to get out of the stock market.  Chinese regulators have suspended trading on many stocks so margin calls are coming from the remaining stocks causing indiscriminate selling.

What does this mean to US investors?  While we feel that it is important to get diversification in our own portfolios within other countries with growth rates greater than the US, it is also important to realize the risks and mitigate.  For example, the Dimensional Emerging Market Core fund that we use in most instances to gain exposure to China attempts to keep the exposure to any one particular country to approximately 15 percent in total regardless of their market capitalization.  As you can see below with the March 31^st 2014 snapshot, the Chinese exposure in that fund was just slightly higher than 15 percent at 16.1 percent given the rapid appreciation of the Shanghai stocks up until then.  Comparatively, the Chinese stock market is approximately three times larger than the South Korean stock market, but Dimensional still maintains similar soft caps on their allocation percentages at 15 percent.

Greece Drama

In assessing the Greek situation, it is very important to realize the relatively small size of the Greek economy.  According to The World Bank, the Greek GDP for 2014 was $237.6 billion.  To put that in context, the Gross State Product for the state of Oregon in 2014 was $215.6 billion according to the Federal Reserve Bank of St. Louis.

Why all the fuss about Greece?  Greece’s debt to GDP level approximated 175.1% in 2013 according to Eurostat.  With their admission to the euro-zone in 2001, they dined on the ability to increase their debt load to fund their socialistic agendas.  In fact in 2004, their former Finance Minister, George Alogoskoufis, said the true scale of Greece’s budget deficit was massively understated in order to drop below the qualification bar for admission into the EU’s single currency.  The European Commission chose not to do anything about it at the time.

Stories about Greek under collection of taxes, generous public pension system, lax rules on early retirement, and unemployment (25.9% in 2014) are endless.  They are truly one of a kind out there in both the scope of their debt problem and the malaise of their economy.  For these reasons, they are not like “the rest” of the EU.

What is concerning and adding to the unknown is how the EU will handle Greece going forward as a member of the euro-zone or their potential exit.  Other countries in the EU that have debt and unemployment problems vaguely close to Greece (Spain, Portugal and Italy) will be watching with a keen eye. Much of the Greek debt has been transferred to the European Central Bank and out of private bank balance sheets.  The direct hit Greece will have on the world may be minimal however, if other shoes start to drop in other countries it could be more problematic causing increased uncertainty in the market.

Conclusion

Whatever the case, examples like China and Greece are why we take the only “free lunch” that can be gained in the markets with diversification and having enough safe assets on the side to access when things get volatile.  As Warren Buffett said in his 2014 annual report, “Anything can happen anytime in markets,” he wrote.  “And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur.  Market forecasters will fill your ear but never fill your wallet.”

What is good about taking risk, is that in most cases it eventually provides a return.  If taking risk was a sure thing, the returns would be next to nothing.  However, it is also important to keep risk in context to prevent us from panicking whenever the next “financial crisis” strikes.

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