Archive for February, 2007

China - Does It Really Matter?

By Vitaliy Katsenelson, CFA 

The market has risen dramatically without looking back, ignoring every possible piece of negative domestic news (e.g. lower home sales, bankruptcies of subprime lenders).  The reaction to the possibility of slowdown in the Chinese economy was an excuse for a correction.  This correction has caught many with their pants down, due to the euphoria of the cyclical bull market. Most portfolios have been assembled for ‘return’, while paying little attention to risk.    

Let’s get the facts straight.  We don’t know if the Chinese economy will actually slow down, but even if it does, despite its populace, it’s GDP is still smaller (or close) than France.  I don’t remember seeing a selloff in the US markets because the some incident in the French economy.  A slowdown in the Chinese economy would have a significant impact on commodities and companies that produce them, as Chinese  demand was the recent driver of commodity prices.  However, a market selloff was telling investors that ‘as goes China, goes the U.S.’  – that is not the case. The inverse is more likely to be true.  That was not why the market was down.  Slower growth of the Chinese economy or even a dramatic slowdown is likely to shave off small bits of our domestic GDP growth – we sell a lot less to them, than they sell to us.  In fact, the Japanese economy, which is three times the size of the Chinese economy, was in a dramatic recession for the past 15 years. However the US economy enjoyed some its best years of prosperity, during this period.    

Investors should check their portfolio for exposure to the health of the Chinese economy, but that is something they should do regularly anyway.  They should look at how much of their companies’ sales come from China. You don’t want to have a portfolio full of companies that sell only to the Chinese.  Also make sure that you don’t have a portfolio full of commodity stocks, as they’ll be on the frontlines of the casualty list if the Chinese economy weakens dramatically.  This drop in the market has created buying opportunities.  Many U.S. companies that declined in price are not greatly impacted by what happens in China, or even by a slower growth rate of our economy. 

6 comments February 28th, 2007

Don’t Let Bull Market Convince You That You Are Smart

By Vitaliy Katsenelson, CFA
February 24, 2007

Lately I’ve been getting this powerful feeling that everything I touch turns to gold. Every time I buy a stock, it goes up. Did I finally figure out the stock market game? Did I find a secret to Will Rogers’ advice? Buy stocks that go up, and if they don’t go up, don’t buy them.

No, I didn’t get much smarter, and my stock picking skills haven’t improved that much over the past year. I was simply a willing participant in the latest (cyclical) bull market. A bull market makes you feel smarter than you are the same way a bear market makes you feel dumber than you are. Feeling smart makes you do the opposite of what you should be doing. The euphoria of the golden touch is a dangerous thing because it can make you (and me) careless. We forget about risk since we haven’t seen it in a while and focus only on our rewards. You have to actively make yourself aware of the four-letter word R-I-S-K!

How do you do that? My favorite way is to remind myself how “dumb” I am. I pull out an annual return report of a company on which I lost a boatload of money and masochistically try to read it from cover to cover, reliving my “dumbness.”

Continue Reading 4 comments February 24th, 2007

The Future of Corporate Profits. The "E" in the P/E Equation

By Vitaliy N. Katsenelson, CFA

I wrote this article last year, on the risk that high corporate margins present to investors.  Here is updated excerpt from that article:

Today’s stock market valuation is higher than it may appear. As margins revert to the historical average (and they always do), corporate earnings growth will either decelerate — disappointing Wall Street expectations of 8% earnings growth (according to First Call) for the S&P 500 over next five years — or decline, driving earnings, the “E” in the P/E equation, down. The broad market index fund investor may be in a pickle when a cheap market suddenly becomes more expensive. If today’s corporate profitability reverts to the mean profit margins observed over the last 25 years (8.8%), corporate profits would decline almost 31%.

 

This chart speaks a 1000 words:

4 comments February 8th, 2007

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