Europe Is Not The Problem!

In my last post I talked about why I think that Europe is not that big a deal to us in North America. That does not necessarily mean that I can sleep with not a care in the world. I just feel that everyone is focussing on Europe and they are potentially missing the big picture, which is China.

Economists are projecting around 4% global growth for this year and next year, or at least they were till Europe blew up. That is a pretty good growth number. We do not believe that the problems in the European periphery will materially impact these numbers. Continental Europe remains in decent shape, and its contribution to global GDP growth will not change materially.

Its China that has us questioning our global growth assumptions for the next 2 years. It feels to us that everyone (including the press) is looking to the right, when the real game is to the left. While everyone is trying to decide how real a Euro contagion scenario is, few are paying as much attention to what is going on in China.

While North American markets are in a correction phase, Chinese markets are in a full blown bear market. The Chinese stock market is already down 20% this year. The markets are telling us that something is wrong in China. The commodity markets provide further confirmation of this concern. Oil is off 12% from the beginning of the year. Copper is down 18% from its highs just 1 month ago. These are some of the commodities that China inc has been buying in large quantities to fuel their building boom.

China is in the midst of a tightening cycle. They have raised interest rates numerous times and they have tightened credit standards. The government is trying to cool the real estate market before it turns into a property bubble. One might question whether the government will be successful or whether they are too late.

The problem in China is that a lot of the real estate development is being done on spec. Sound familiar? Real estate is not being built for buyers who will occupy them, but for speculators who are buying them on leverage. This game of musical chairs continues until the speculators cannot unload the properties at ever higher prices or their loans get called.

The real question is, can the Chinese government slow the property market down without killing their economy (and the growth prospects for the global economy)? Not sure what the answer is, but that is what I believe is going on in the markets this week.

I have heard a lot of questions of why the markets are selling the Canadian dollar when the US Dollar is strengthening against the Euro? Seems counter intuitive that investors would sell Canadian Dollars when they are worried about countries with large fiscal deficits (Europe). Canada is actually in way better fiscal shape than the US. But, it makes perfect sense if one considers that that the Canadian Dollar is weakening along with commodity prices and a potential weakening of global growth prospects. Canada sells a lot of commodity stuff to China and if China slows, they will be needing less of the raw materials we sell to them (and at lower prices).

This thesis is also corroborated by the performance of the industrials and technology stocks over the last few days. These companies are most exposed to global growth and they have been the poorest performers over the last week.

In my next post I will talk about how we are investing in this climate.