Don’t call me Dr. Doom, call me Mr. Realist

in China/FP: Latest/Japan/The Process by

 I had an interesting conversation last week with a potential investor.  I described my thoughts on the US economy, explaining that in our (my firm’s) view the current strength of the US economy is significantly boosted by steroids graciously provided by the US government in the form of stimulus.  (I’ve written about it in this article.)   I explained that since stimulus exaggerates the true performance of our economy, we’ve positioned our portfolio through stock selection for a subdued, low-growth type of recovery.  

Then I shared my concerns about the Chinese economy – it has tremendous overcapacity in the commercial and residential real estate and industrial sectors (see this presentation: “China – The Mother of All Black Swans”).  As the Chinese economy painfully readjusts and chews through the excesses, Chinese demand for industrial, energy, and commodity goods will be significantly lower.  Thus in our portfolios we have reduced our exposure to these sectors.  

And finally, I explained our views on Japan.  As you’ll see from charts in the attached presentation (“Japan – Past the Point of No Return”), Japan has an enormous amount of debt (second only to Zimbabwe), a stagnating economy, and the oldest population in the world (this explains why the savings rate has declined from the teens towards zero).  These factors will lead to significantly higher interest rates.  

As an unbiased analyst it is hard to come to any other conclusion about Japan, and I am going to put it lightly: Japan is screwed!  As a consequence, we believe higher interest rates globally are unavoidable, as Japan, now the largest foreign holder of the US Treasuries (together with  China, the second largest holder), turns from buyer of Treasuries to net seller.  So in our portfolio we are making sure that our companies have strong balance sheets and/or significant free cash flows to pay off debt, if (more likely when) interest rates rise.   

With every country mentioned the potential investor got paler and paler; and before I got to the EU, a union that was created, as my friend John Mauldin put it, for prosperity not adversity, he exclaimed, “You are Dr. Doom!” 

I don’t have a PhD, thus I can only be called Mr. Doom – but I am not that either.  A joke told by Warren Buffett comes to mind: a patient, after hearing from a doctor that he has cancer, tells the doctor, “Doc, I don’t have enough money for the surgery, but maybe could I pay you to touch up the x-ray?”  Hope and self-deception are not a strategy.  I analyze and accept the conclusions of my analysis, no matter how painful they may be, and adjust my actions according to my findings.   I am neither a pessimist nor an optimist, I am a realist. So at my firm we look at risks and constantly ask ourselves: What can we do to avoid them (or benefit from them) in our clients’ portfolios?  So don’t call me Mr. Doom, call me Mr. Realist. 

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).  To receive Vitaliy’s future articles my email, click here.


  1. I have tremendous respect for your thoughts and writings, and I agree there are bubbles in China (SH real estate is one), but isn't part of your skepticism toward China skewed by the fact its looks like Russia to you, Mr 8842 ?

  2. Vitaliy,
    You China- Mother of all Black Swans has 'upset' some folks in that region. I saw a couple of reports, which try to dispute your analysis. I can appreciate the fact that you think China is one black hole and information from them can not be trusted as govt has a firm grip on things. However I was wondering what makes China information less trust worthy than that of US government? Is the unemployment really 10%. Did Obama's policies really save or create 2 million jobs (I love this one, they do not even know whether they created or saved jobs)? Can we really trust the health care benefits & costs proposed by the administration (it seems that many of congress people have not even read the full proposal)?
    I hear you point about americans being united, but lets be honest, many finally realizing that paying for others 'misfortunes' (stupid mistakes) has got to end and Socialism is not something America is ready for at the moment though may at some later point. It took Russia over a decade to embrace Capitalism.
    I believe that in order to make the right assessment one needs to be on the ground to see it for himself/herself. Otherwise it is just an educated guess
    My 'educated guess' is that China learned the US lesson and takes steps to prevent real estate from overheating further. China learned the US lesson and hence banks require a 30%-40% downpayment when purchasing a house. China's savings rate is much much higher than of US, hence consumer is not over leveraged. And of course China has the growing wealthier consumer. Perhaps not millioners but an extra couple of hundred dollars for 1 billion people may have the same if not bigger effect in terms of demand.

  3. China's public sector has low leverage which amounts to <55% of GDP, this is using Victor Shih's bearish but also flawed analysis, excluding credit lines that haven't been drawn down.

    China's housing market has even lower leverage, 25% of all home purchases are on cash, 30-40% with more than 40% cash down payment, rest between 20-30%.

    Your chart on China's electricity production is not up to date and China did see GDP slowed down to low single digit in 4Q08-1Q09. Govt didn't lie… but, it seems that you are..

    Your Ordos' picture was taken right after the city was built and it is pretty much filled by now. I was just there last month… Btw, the new city of Ordos finished building before financial crisis and was not a result of GDP target, rather it was b/c the city govt is rich and the old city was really congested, thus mayor decided to do some “deeds” for its citizens to build a brand new city for them and the project was paid all by cash….

    Dude, you need to do more research before making your “contraian” calls. Don't be like James Chanos or the pivot capital guys with their flawed 30mins analysis…

  4. Since China has such strong government control, what is to stop them from simply printing money (without borrowing it) to fill any bad debt holes that exist? It is not like any of us would ever know. As I see it, the only real constraints on China's growth are natural resource limits – primarily energy resources. It will be a long time before every Chinaman has a house full of all the latest toys and a car and nice roads to drive that car on. So it will be a very long time before their demand side of the equation is completely saturated. All China's “overcapacity” can be utilized as they make a transition to a consuming economy.

    But global oil supply has peaked and production is now in slow decline. Oil at $80 in the middle of a recession is ample evidence of a true supply constraint. Everyone is competing for the same supply of oil. I don't know when crunch time comes, or how it will play out, but I expect things could get really ugly.

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