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This could be capitulation from the trade in 2013 which saw massive shorting of Canadian banks by U.S. investors on the view that our housing market was significantly over-valued, and that its impending collapse would have the same negative repercussions for Canadian bank stocks as it did for the U.S. financial stocks in 2008. Clearly that scenario did not (or has yet to) occur and banks have rallied by over 35% over the past year. While valuations of Canadian banks are at the high end of their typical range, the dividend yields are still highly attractive in this low interest rate environment. More importantly, though, bank earnings have started to grow more quickly again as loan growth improves and wealth management businesses continue to expand. Canadian banks have also done well with acquisitions over the past few years, particularly by TD Bank in the U.S. Although we have lightened up our position in U.S. and Canadian banks recently, we still have significant positions in Royal, TD and National Bank in Canada as well as JP Morgan and Citigroup in the U.S.
When it comes to China, it really suffers from the ’Rodney Dangerfield Effect’. As the late comedian’s famous tag line went, “I don’t get any respect.” The same could be said of the Chinese economy and stock market. It has been one of the worst performing stock markets since the lows in 2009. In 2013 the Shanghai Index lost 7.6% versus gains of over 25% for the German Dax, 29% for the US S&P500 and over 56% for the Japanese Nikkei! Investors seem to continually fear the collapse of the Chinese economy as problems from their ‘shadow banking’ system and overbuilding of capital structures lead to ‘empty cities funded by bad loans.’ The actual data shows a completely different story though. China’s economy has slowed three times in the 33 years for which quasi-reliable data are available. However, it has not contracted since it “took-off” on a path of modernization in 1979. Studies of emerging economies show no instances of modernization stalling once the conditions for take-off have been realized. Over the last three-plus decades, China’s GDP growth has averaged 9.7% per year. What other country can say the same?
These growth fears are reflected in China’s under-valued stock market. Stock markets in emerging Asia all look cheap with the MSCI Asia Pacific index trading at 11.9 times forward earnings, below the long-term average of 12.5 times, despite consensus earnings growth of 13.1% and 11.4% for 2014 and 2015. But if you look at the individual markets, you realize emerging Asia looks cheap only because China is dirt cheap. All other markets are already at their long-term averages or way beyond. MSCI China trades at 8.5 times, about 29% below the 11.9 times long-term average.
By all measures, China’s GDP is catching up with that of the United States and Europe. China’s real GDP was already equal to 87% of the U.S. economy in 2011. China could overtake the United States in real economic size this year. Rather than accept this inevitability, analysts find a better “sell” for stories that foretell China’s economic collapse. These are all big headline eye catchers: Growth is unbalanced. Banks are unstable. The currency is undervalued. The environment is too polluted. Demographics are unsupportive. Energy is not available. Commodity supplies cannot rise to support China’s growth. But this is not an economic contest that is being lost. That is the wrong way to think about it. China’s population is four times that of either the U.S. or Euroland. So it stands to reason that its GDP ought to be four times bigger when its modernization is complete.
China has already embraced Western ideas; our universities are well represented with students from China who come to learn our languages and cultures, our business practices, our technologies and our ethics. English is already spoken in most cities in China. The West is betting on China’s economy failing but we don’t see that as the ultimate outcome. Doomsday stories may sell books, but good stories are not necessarily good analysis. China’s story is unlikely to have a crash-and-burn ending and its continued growth and modernization will push it into the top global economic spot at some point in the next 20 years. Prepare for a new world economic order with China as its leader, as it has been in 18 of the last 20 centuries! In the short term, however, the Chinese stock market looks like a relatively cheap play on an exceptionally strong long-term growth story.
Clearly we have become much more cautious about the outlook for stocks than we have been at any time since the financial crisis. The easy money policies of the world’s central banks have been in place longer than they need to be and have lead to a higher degree of speculative activity in parts of the stock market. While the global economy continues to expand and corporate earnings continue to grow, valuations have become extended and in need of some retracement. Our trepidation about the short-term outlook for stocks is shared by many strategists, yet we clearly remain bullish compared to some of the more extreme views out there right now. ‘Perma-bear’ John Hussman, in his weekly commentary, provides such a view: “This is an equity bubble, and a highly advanced one. On the most historically reliable measures, it is easily beyond 1972 and 1987, beyond 1929 and 2007, and is now within about 15% of the 2000 extreme. The main difference between the current episode and that of 2000 is that the 2000 bubble was strikingly obvious in technology, whereas the present one is diffused across all sectors in a way that makes valuations for most stocks actually worse than in 2000.” Now that’s a cautious outlook!