V. ANAN­THA NAGESWARAN

DO VAL­U­A­TIONS MAT­TER?

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The

com­bined mar­ket value of Ama­zon, Al­pha­bet, Mi­crosoft and In­tel stocks is around $2.1 tril­lion—a lit­tle short of In­dia’s gross do­mes­tic prod­uct (GDP). A year ago, the mar­ket cap­i­tal­iza­tion was around $1.55 tril­lion.

That is a jump of $565 bil­lion—36%. In con­trast, their earn­ings for the three months end­ing Septem­ber 2017 was higher by $3 bil­lion over the third quar­ter of 2016. Ir­ra­tional ex­u­ber­ance is back with a vengeance. Cen­tral banks around the world— prin­ci­pally China—can take credit. In the face of easy money, analy­ses based on fun­da­men­tals are of lit­tle value.

They do not mat­ter. The in­vest­ment world is miss­ing the child that called out the em­peror’s nu­dity. But, one day, the child in in­vestors will wake up and usu­ally, it is too late.

A story in the South China Morn­ing Post pub­lished on 14 Oc­to­ber 2017 gives us some clues as to what has been driv­ing the so-called global eco­nomic re­cov­ery that al­legedly un­der­pins the rally in all risk as­sets around the world.

The story is about the gov­ern­ment-owned Dong­bei Spe­cial Steel Group Co. Ltd that was on the verge of clos­ing down. The gov­ern­ment in Bei­jing forced a bank­ruptcy through with cred­i­tors tak­ing a 78% hair­cut on their dues, much against their wishes. What is in­ter­est­ing is that the story men­tions glut con­di­tions in the global steel mar­ket in 2014 and in 2015 that turned into a rally in steel prices in 2016.

Usu­ally, glut con­di­tions do not dis­ap­pear so quickly and their im­pact on prices lingers, with their ef­fect re­ced­ing only grad­u­ally. Global growth did not re­ally pick up all of a sud­den, spon­ta­neously. What has been at work is an ex­tra­or­di­nary jump in China’s liq­uid­ity and loans in 2016, sim­i­lar to what was un­leashed in 2009.

As­sets held by the Chi­nese bank­ing sys­tem—on and off bal­ance sheet—con­tinue to climb. Even if some of the ex­plo­sive growth in off­bal­ance sheet as­sets in­di­cated by the Peo­ple’s Bank of China in its “Fi­nan­cial Sta­bil­ity Re­port 2017” was due to re­clas­si­fi­ca­tion or dou­ble count­ing, the fact re­mains that the growth rate of on-bal­ance sheet as­sets was 16.5% in 2016. Gold­man Sachs had es­ti­mated that “To­tal So­cial Fi­nanc­ing” (TSF) rose over 15% in 2015 and in 2016. TSF is the most com­pre­hen­sive of­fi­cial mea­sure of credit in the econ­omy, and not just from bank­ing sources. Nom­i­nal GDP growth in China in those two years was 6.9% and 10.0%, re­spec­tively. TSF had risen faster than nom­i­nal GDP.

In other words, the re­cov­ery in the prices of com­modi­ties and in the out­look for global growth can be traced to a mas­sive in­fu­sion of liq­uid­ity by China over the years, con­tin­u­ing into 2017, the year of the Com­mu­nist Party congress.

In Septem­ber 2017, the TSF growth rate was 14.3%, ac­cord­ing to Gold­man es­ti­mates. We should not ig­nore the con­tri­bu­tions be­ing made by the Bank of Ja­pan (BOJ), the Euro­pean Cen­tral Bank (ECB) and smaller Euro­pean cen­tral banks such as the Swiss Na­tional Bank. The ECB will de­cide in its meet­ing later this month if it should an­nounce a timetable for end­ing its monthly as­set pur­chases. It is a long way off from ac­tu­ally ceas­ing its as­set pur­chases.

Mac­quarie Re­search wrote re­cently, “We main­tain that the best ex­pla­na­tion for in­vestors’ per­cep­tion that risks are low is that a com­bi­na­tion of cen­tral banks’ liq­uid­ity (still run­ning at about $1.5-2.0 tril­lion per an­num), an as­sump­tion that cen­tral banks would swiftly re­verse their poli­cies at the slight­est sign of volatil­ity re-emerg­ing, and China’s real es­tate and in­fra­struc­ture in­vest­ment, act as ‘risk buf­fers’.” They reckon that the global re­fla­tion set off by China in the sec­ond quar­ter of 2016 con­tin­ues. Our anal­y­sis above con­firms that. With China not slow­ing down its cre­ation of debt—not­with­stand­ing re­peated protes­ta­tions to the con­trary—and with the ECB and BOJ not re­lent­ing ei­ther on their liq­uid­ity cre­ation, the global re­fla­tion trade con­tin­ues. On 25 July, in these pages, yours truly had ex­pressed his mis­giv­ings about the so-called global eco­nomic re­cov­ery (“Is The Global Eco­nomic Re­cov­ery Sta­tis­ti­cal Or Real?”). It was only a hunch. Now, there is con­fir­ma­tion. China’s liq­uid­ity and lever­age or­gies ex­plain the phan­tom re­cov­ery.

The an­a­lysts at Mac­quarie reckon that this has to con­tinue lest the Ponzi ar­range­ment of fi­nan­cial in­stru­ments backed up by “as­sets that are ei­ther worth­less or de­clin­ing in value” ends vi­o­lently.

Liq­uid­ity and lever­age main­tain the cha­rade that these fi­nan­cial in­stru­ments are worth some­thing. They back the “per­pet­ual dooms­day ma­chine” that global fi­nan­cial mar­kets have be­come to con­tinue hum­ming, for that is the only way to keep the show go­ing. The only risk, ac­cord­ing to them, is if cen­tral banks and China ac­tu­ally mis­judge that the re­cov­ery is self-sus­tain­ing and pro­ceed to tighten pol­icy. Or, if some in­vestor ac­tu­ally asks the tough ques­tion about the in­trin­sic value of fi­nan­cial as­sets—whether tech­nol­ogy stocks or emerg­ing mar­ket bonds or euro high-yield (Bb-rated bonds). If no one asked the ques­tion, the show can go on be­cause it must—for there is no other way. There is no hon­ourable or safe exit.

Bare Talk read­ily ad­mits that it does not know when the party will end, when the lights will be turned off and when the last guest will stag­ger off the stage, not know­ing what he was do­ing be­fore and where he is headed next. But all par­ties do end. If you are not con­vinced, try ask­ing Har­vey We­in­stein.

V. Anan­tha Nageswaran is an in­de­pen­dent con­sul­tant based in Sin­ga­pore. He blogs reg­u­larly at The­gold­stan­dard­site.word­press.com.

Com­ments are wel­come at baretalk@livemint.com

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