Globalization and China, Once Again

By: Henry To | Mon, Apr 11, 2005
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Readers who have kept track of my views on China and on globalization should have "noticed" and read all my commentaries about China - especially the three commentaries that I wrote on the background and current issues on China earlier this year (which are available in our archives). In the final part of that three-part series, I discussed the fact that even though China has been running a huge trade surplus with the United States, it is, at the same time, running a deficit with the rest of the world - most notably, the rest of Asia. Moreover, China's total trade balance has been shrinking since 1998 - given China's huge and increasing appetite for commodity items and huge machinery.

Here's another thing: In those articles, I discussed the fact that the economic effect of the increasing China and India's global influence was overstated (again, look at the ramblings of Lou Dobbs) in the short-run but understated in the long-run. The reason is this: Most people tend to live in the present. Most of us also do not have the necessary long-term vision (part of which is because of our ignorance of history) and moreover, most of us do not want to think about our goals for next year, let alone something that could/would happen ten years from now. This is the underlying problem of the average American today. The global influence of China and India is increasing, and it cannot be deterred - short of a war between the United States/Taiwan and China.

Hopefully, my remarks on the decreasing trade balance of China back in February have not made our readers complacent (I am sure our average reader is more "paranoid" than most, however). Because, if you were, then you'd have been taken surprised by this latest article from the New York Times: "Made in China. Bought Everywhere." The article began by saying that China had a trade surplus of $33 billion in 2004, "but [that] if trade with the United States is excluded, China actually ran a deficit of $47 billion with all other countries combined." If the first two months of 2005 indicates an ongoing trend, however, this may be all set to change. I will quote:

Yet, with 36 percent more exports landing on foreign shores in January and February, China ran a $10.9 billion trade surplus with the world in the first two months, compared with a $7.9 billion deficit for the period a year ago.

While toys, clothing, furniture and television sets from China have dominated the shelves of American retailers for years, these and newer products like portable electric lamps and even radio navigation equipment are being shipped in growing quantities to countries ranging from Britain and Spain to Brazil and Indonesia, according to recently released Chinese customs data.

At the same time, China is entering global markets in which it previously played little role. It is becoming a large exporter of commodities like steel and chemicals, with steel exports nearly quintupling in the first two months of 2005 compared with a year ago. China is importing fewer cars and less heavy machinery as more of these are made in China, and companies make plans to export more cars and machinery.

The Commerce Department plans to release trade figures on Tuesday, and experts expect that the nation ran another big deficit in February with China. But statistics already released by Beijing show that Chinese exports to the United States climbed 36.8 percent in the first two months of this year, while American exports to China fell by 9.7 percent.

Chinese exports to many other countries rose even faster, while its total imports increased by only 8 percent. Exports to Britain rose this year by 42 percent; to Germany, 44 percent; to Canada and Italy, 59 percent; and to Spain and Indonesia, 75 percent, compared with the period last year.

One big shift in trade is starting to take place in global steel markets. China has become the world's largest steel consumer. But Chinese steel production has risen even faster, as practically every province has erected steel mills.

Germany, which has benefited for years by selling machinery and manufacturing equipment to China, had a trade surplus of $1.24 billion with China in January and February of last year that has turned into a deficit of $316 million in the first two months of 2005. Italy ran a $181 million trade deficit with China in January and February of 2003 that widened to $256 million in 2004 and $812 million for those months this year.

But economists say this is not just the effect of the weaker dollar. Much of the export growth, Stephen Roach, the chief economist at Morgan Stanley, said, is the cumulative effect of foreign multinationals building up their Chinese production.

The two big questions now puzzling executives and economists are whether China's trade surplus will continue to widen and whether it will prompt protectionism in industrialized countries. Of course, China still runs big deficits with oil-producing countries, notably Saudi Arabia and Angola. But even with oil close to $60 a barrel, demand for Chinese goods is running far ahead of China's costs for the energy needed to make them.

But with exports rising now, the United States and European Union officials have begun objecting, mainly to China's textile and apparel exports, which are no longer limited by the global system of quotas that expired at the end of last year.

American and European apparel producers have been extremely upset, but manufacturers in many other industries have been less concerned so far. "It is likely for the near term that the export-import situation out of China will ebb and flow," said Terrence Straub, the senior vice president for public policy and government affairs at the United States Steel Corporation.

I may have quoted most of the article here, but I believe it is imperative that all my readers read the above paragraphs. Another "authoritative voice" on the subject of globalization is Mr. Thomas Friedman, a New York Times foreign correspondent and winner of the 2002 Pulitzer winner for Commentary. He is also the author of "The Lexus and the Oliver Tree" - a definitive book on globalization written in 1999 - which is actually a long time ago in cyberspace time. I have not personally read his latest work "The World is Flat: A Brief History of the 21st Century," but I believe it will offer great insights to our readers who are interested and concerned about globalization (which everyone should be). In a book review, however, Friedman did mention that 400,000 Americans will have their taxes done by Indian accountants this year, while 245,000 in new call center jobs were added in 2004. The United States loses out on demographics as well, as the combined young population of China and India outnumbers that of the U.S. 60 to 1. If it is of any consolation, it is the fact that Western Europe will most likely have a rougher time than us going forward (or "toast," as Friedman have said in various interviews).

All this is not a pretty sight - as the average American who are directly involved in manufacturing or other jobs that are easily replaceable would lose out in the long-run. Income earned by workers in jobs that are relatively unskilled (and which don't need to be localized) will converge with incomes earned by similar workers in other places of the world, especially in China and India. I may be stating the obvious here, and I bet the average American is nodding his/her head agreement. At the same time, however, I don't think the average American who has a job right now will think his or her job will be outsourced in the near future. No, most Americans today will not see it coming until it actually happens to him or her. Think about it: What kind of jobs can ultimately be outsourced? Programming jobs and accounting functions, for example. How about technical support? Research in the biotech/investment advisory industries and automotive designs and engineering. On top of this, the advent of technology has leveled the playing field. Full service brokerages no longer have a viable business model. Already, executives at major brokerage firms are worried that commissions will go to or near zero in the near future. Neither is a traditional travel agency. The cost of human capital will continue to decline as we move on to the 21st century (that means healthcare and retirement benefits here in the United States and Western Europe will decline as well). To succeed in this environment, one will need to differentiate oneself - whether in educational level, sales skills, knowledge sets, or a combination of all these three.

Of course, I am not envisioning a bleak world. Americans have always been very innovative when it comes to creating jobs or whole new different industries, and small and nimble businesses are continuing to do so at a rapid pace. If history is any guide, fully 40% of occupations 20 years from now will be in completely new industries. Whether these occupations or jobs will pay as relatively well today is another matter. However, the developed well should continue to embrace the "economic miracles" in China and India today, as the continued developments of top talent in both China and India will no doubt bring huge technological breakthroughs in a much quicker way and help accelerate economic growth around the world as well. My personal belief is that the real median income will continue to grow here United States in the next 20 years, but it will be far outpaced by the growth in median incomes in China and India (and growth in the U.S. median income from the 1980s to today), and the income of top talent both here and around the world. I am an optimist, but also a realist, at heart.

Okay, let's now discuss the stock market. In last weekend's commentary, I discussed that with "the Dow Industrials closing at its lowest level since January 24th, there's a distinct possibility that I won't find a good entry point to establish a 50% short in our DJIA Timing System before favoring the long side (which is still very far away, however) once again." Well, we got our oversold bounce from Monday to Thursday. Both the McClellan Oscillator and the high-low differential turned positive on Thursday evening, and as late as Friday morning, I thought the market (per the major indices) will go higher and enjoy another significant rally before it will allow the shorts to make money (and to allow us to go 50% short in our DJIA Timing System) again. Alas, it was not meant to be.

As Friday rolled along, the market started a steady decline. One may not notice this by just looking at the major large cap indices, but the transportation stocks took a huge dive on Friday - led by the trucking industry - which could have been foreseen as early as a couple of weeks ago when WMT made a two-year low. If retailers are experiencing a slowdown, then the truckers (the ones that are hauling the goods to the retail stores) must be suffering as well. Following is the latest chart of the Dow Jones Industrial Average vs. the Dow Jones Transportation Average:

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (January 1, 2003 to April 8, 2005) - The Dow Industrials rose 57 points while the Dow Transports lost nearly 90 points for the week.  The news item was the week in terms of the Dow Theory was the breakdown of the Dow Transports on Friday - with a one-day decline of 122.3 points ('helped' by the decline of USF and the truckers in the Dow Transports Index).  The Dow Transports is now at a low not seen since February 22nd.  Like I mentioned last week, a logical bounce point for the Dow Transports is 3,500.

The market basically looked good until Friday. I never like it (from a bullish standpoint) when the market close the week in a very weak technical condition. Last Friday was one of those times. The 3.29% decline in the Dow Transports was huge, especially in light of steadily lower oil prices during the week. For comparison purposes, a similar percentage decline in the Dow Industrials would have meant a decline of approximately 350 points!

What are the important themes in the upcoming week, you may ask? Well, my readers should know that we should continue to keep track of the ongoing developments at AIG, FNM, FRE, GM, and General Re. As I mentioned in last week's commentary, the successor to Pope John Paul II will also have a huge role (if he chooses to) to play in geopolitics and in the world economy going forward, and so I believe that our readers should keep track of the election process as well - even though we will not know the results until the week after, at the earliest. As I have also discussed in our discussion forum, Wal-mart (WMT) is another stock to watch. The stock is now near a two-year low, and any further fall here would suggest a huge cutback in consumer spending going forward. One of the mutual funds' favorites, Starbucks (SBUX, and a personal favorite place to go to for me - many a commentary had been written at the local Starbucks) reported sales for March that were below estimates, and the stock is now trading below its 200-day moving average - something that it has not done since over two years ago. When the shares of both the biggest and the fastest-growing retailers act sickly (as they are now), you definitely should listen!

An important index to keep track of is the Philadelphia Bank Index - something that has always been emphasized in our commentaries. Readers may recall that the relative strength of the Bank Index vs. the S&P 500 has broken down from a two-year support level more than two months ago. Since then, the relative strength of the Bank Index has continued to lag - and shows no signs of recovering. This is especially important as the fundamentals (the fact that we are now very late in the liquidity cycle with the yield curve flattening) definitely do not support a recovery either. Following is the weekly chart of the absolute level of the Bank Index:

Philadelphia Bank Index - Weekly PPO has been weak since late 2003 and has grown substantially weaker during 2004. Notice how the BKX is potentially tracing out a 'heads and shoulders' top here.  A breakdown below is 'neckline' in the 92.5 to 95 area would be most bearish and would indicate the topping out of the Bank Index not only on an absolute basis but on a relative basis with the S&P 500 as well.

As the above chart indicates, the weekly PPO (a momentum oscillator) topped out in early 2003 and has grown substantially weaker since the end of 2003 - even as it made a new recovery high in early 2004. Despite the maturing of the cycle during 2004, the Bank Index has held its own - making a slightly higher high at the end of 2004. The weekly PPO, however, did not confirm, as it concurrently made a lower high than the high in early 2004.

I believe that the rise in the Bank Index on both an absolute basis and a relative basis (vs. the S&P 500) is now near an end. The Bank Index has now traced out a potential "heads and shoulders" topping out pattern - and given the fundamentals of the current liquidity and credit environment, I believe there is a high chance that the "heads and shoulders" pattern will complete itself and break through its neckline in the 92.5 and 95 area. Readers should definitely keep track of the Bank Index in the upcoming weeks. Any decline below 95 on a closing basis should be heeded as a warning!

The message coming out of the sentiment indicators, meanwhile, is pretty much unchanged from last week. The AAII survey is very oversold, but most of my other sentiment indicators are only at slightly oversold or even neutral levels. For example, the 10-day NYSE ARMS Index is still only at 1.13 - a level that is nowhere near oversold. Like I said before, at this point in the cycle, I would like to see a 10-day ARMS reading greater than 1.50 before I would be willing to call a bottom in the stock market.

Now, I have made a promise to my readers last week that I will go ahead and update the chart of the Conference Board's Consumer Confidence Index vs. the Dow Jones Industrial Average. In my previous commentaries, I have outlined the importance of the Consumer Confidence Index as a contrarian indicator. Most notably, in my August 8th, 2004 commentary, I stated: "Now, onto Consumer Confidence data straight from The Conference Board. I have posted this chart before - I initially got the idea of constructing this chart from Mr. Richard McCabe, Chief Market Strategist at Merrill Lynch. In a presentation that he made earlier this year in Houston, he suggested that we used the Consumer Confidence data as a contrarian indicator. So far, history has backed his justification - it has been a pretty reliable contrarian indicator so far." Throughout 2004, I have said over and over again that I would like to see a Consumer Confidence Index level of below 90 before I would be confident in calling a bottom in the Dow Jones Industrials (since the Dow Industrials is the most well-known stock market index in the world and among U.S. consumers). Well, we got a 90.5 reading in November 2004, and since then, Consumer Confidence has steadily risen again - hitting a high of 105.1 in January 2005. Consumer Confidence hit a level of 102.4 at the end of March, but this is still very far away from a sub-90 reading. A sub-90 reading is all the more essential given we are this late in the liquidity cycle and in the cyclical bull market. Following is a monthly chart of Consumer Confidence vs. the DJIA:

Monthly Chart of Consumer Confidence vs. DJIA (January 1981 to March 2005) - From a contrarian standpoint, the March Consumer Confidence reading of 102.4 is definitely not low enough to signal a sufficiently oversold market here.  For comparison purposes, Consumer Confidence sank to as low as 90.5 during November 2004.

The Consumer Confidence Index is a slightly lagging indicator, and it is definitely not a good tool to use in short-term forecasting. That being said, the important thing to consider here is this: Consumer Confidence Index hit 102.4 at the end of March. It is doubtful that this will hit a level below 90 if we were to compile the results of another similar survey today. Confidence levels and attitudes take awhile to change - at the very least, it will take a few more weeks.

Okay, so the Consumer Confidence Index is still slightly overbought relative to the readings of the last two years. What about the other popular sentiment indicators that we keep track of here at Like I said previously, the message of these sentiment indicators do not change from last week. While the Bulls-Bears% Differential is at a very oversold level, the readings from the Investors Intelligence Survey and the Market Vane's Bullish Consensus are still not confirming. I will first start off with the Bulls-Bears% Differential in the Investors Intelligence Survey vs. the Dow Jones Industrials:

DJIA vs. Bulls-Bears% Differential in the Investors Intelligence Survey (January 2003 to Present) - The Bulls-Bears% Differential in the Investors Intelligence Survey further decreased from 23.6% to 18.7% in the latest week - the lowest reading since the  15.9% and 19.4% readings in early September 2004.  Again, while this reading is definitely getting oversold, it still hasn't fully confirmed the extremely oversold readings of the AAII survey just yet.

As expected, the bulls-bears% differential in the Investors Intelligence Survey declined again this week - from a reading of 23.6% to 18.7%. This reading is the lowest reading since the 15.9% reading in early September 2004. However, like I have said before, I would like to see a sub-10% reading here (and a lower reading than the late August 2004 low) before calling for a tradable bottom.

Meanwhile, the readings in the Market Vane's Bullish Consensus actually became slightly overbought in the latest week - rising from a reading of 61% to 63%:

DJIA vs. Market Vane's Bullish Consensus (January 2002 to Present) - The Market Vane's Bullish Consensus reading actually increased from 61% last week to 63% this week.  The reading from last week puts it right on par with the late January 2005 reading (another similar reading would be the 60% reading we got in late October 2004).  However, I do not believe that this 61% reading is overly low and is actually a bit on the high side.  Based on this indicator and the action of the market thus far, there should be more downside both in the readings of this survey and the Dow Jones Industrials.

Like I mentioned in the above chart, the reading of 61% last week is definitely not low enough to construe as an oversold condition. Moreover, given the increase to 63% in the latest week, the Market Vane's Bullish Consensus is definitely telling me that lower prices are right up ahead.

Pretty much the only sentiment survey going for the bulls right now is the Bulls-Bears% Differential readings in the American Association of Individual Investors Survey. For the last three weeks, the readings in this survey had been at a very oversold condition, and yet, the market has refused to rally. More important, the oversold readings in this survey are not being confirmed by my other sentiment or technical indicators. As I said last week: "The message remains the same: The last time such a divergence occurred was in early July 2002. I think the market is now ripe for a watershed decline - a watershed decline which will take us below the August 2004 levels and which will finally give us a tradable bottom once again. If we have a hard bounce this week, then we will go short in our DJIA Timing System. If not, then we will sit it out and wait and then go on the long side once we believe the market has achieved "capitulation."" The message again remains the same this week - we actually may have very well already gotten our rally (a rally which relieved the oversold conditions of some of my technical indicators) from Monday to Thursday of last week. Following is the latest weekly chart of the Bulls-Bears% Differential in the AAII survey vs. the DJIA:

DJIA vs. Bulls-Bears% Differential in the AAII Survey (January 2003 to Present) - The Bulls-Bears% Differential in the AAII survey decreased from increased from negative 23% to negative 18% this week - again suggesting a very oversold situation solely based on this indicator - and a reading not seen since late February of 2003!  The message does not change from last week: Bulls and bears alike better be careful here!  We may see a watershed decline here to finally achieve capitulation or we may finally see a hard bounce this week.  Either way, I do not believe we have seen a bottom in the stock market yet.

Despite the rally during the early part of this week, the bulls-bears% differential has refused to budge - with only an increase of 5% from negative 23% to negative 18%. Again, under "ordinary circumstances" we would be going fully long based on the extremely oversold readings in the AAII survey. However, these are not "ordinary" times.

The last time such a divergence occurred was in early July 2002, and more or less, the May to June 2002 period as well. For illustration purposes, following is a weekly chart of the bulls-bears% differential in the AAII survey vs. the DJIA during the January 2001 to December 2002 period. You may well be surprised!

DJIA vs. Bulls-Bears% Differential in the AAII Survey (January 2001 to December 2002) - Please keep in mind that the greatest declines in the past have come when the AAII Bulls-Bears % Differential were at oversold readings - similar to today's situation.  Note that oversold readings in the AAII survey during April and May of 2002 - immediately prior to the June to July 2002 watershed decline.  The same argument can be made for the period immediately prior to the August to September 2001 decline.

Witness the oversold readings in the AAII Survey that we got during the June to July 2001 and the April to June 2002 period - right before the watershed declines of the Dow Jones Industrial Average (and the major market indices) immediately after. Interestingly, the readings coming out of the Investors Intelligence Survey did not confirm the oversold readings in the AAII Survey during the June to July 2001 and the April to June 2002 periods either.

Conclusion: Hopefully, our message is still clear: We are now very late in the cycle and any hint of a tradable bottom here should be taken with a grain of salt. For our readers, I would like you to be careful before jumping in on the long side - please wait until all our technical indicators get more oversold before buying. Reasons such as a lower oil price are not a strong enough argument. In fact, a lower oil price is bearish at this stage, as it most probably signals a slowing world economy going forward. Lower prices are ULTIMATELY bullish for the stock market, but for all we know, the Dow Industrials can decline another 10% here before lower oil prices are viewed as beneficial to the economy. The intermediate-term trend is now down, although the major indices can still bounce a bit more in the beginning of this week. If that does happen, then we will most likely be going short in our DJIA Timing System by the middle of the week. If the market continues to just go down here, then we will sit this one out and ultimately go long once we find a reasonably good buying point.

Signing off,


Henry To

Author: Henry To

Henry K. To, CFA

Henry To, CFA, is co-founder and partner of the economic advisory firm, MarketThoughts LLC, an advisor to the hedge fund Independence Partners, LP. is a service provided by MarkertThoughts LLC, and provides a twice-a-week commentary designed to educate subscribers about the stock market and the economy beyond the headlines. This commentary usually involves focusing on the fundamentals and technicals of the current stock market, but may also include individual sector and stock analyses - as well as more general investing topics such as the Dow Theory, investing psychology, and financial history.

In January 2000, Henry To, CFA of MarketThoughts LLC alerted his friends and associates about the huge risks created by the historic speculative environment in both the domestic and the international stock markets. Through a series of correspondence and e-mails during January to early April 2000, he discussed his reasons and the implications of this historic mania, and suggested that the best solution was to sell all the technology stocks in ones portfolio. He also alerted his friends and associates about the possible ending of the bear market in gold later in 2000, and suggested that it was the best time to accumulate gold mining stocks with both the Philadelphia Gold and Silver Mining Index and the American Exchange Gold Bugs Index at a value of 40 (today, the value of those indices are at approximately 110 and 240, respectively).Readers who are interested in a 30-day trial of our commentaries can find out more information from our MarketThoughts subscription page.

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