Saturday, July 18, 2015

China Crash -> U.S. Crash?! and Great Book

A lot of people are talking about how bad China is.  It's worse than the U.S. 2007, it's worse than Greece, it's worse than this or that.  It seems like the big China bubble is blowing up.  But so what, right?  Who cares what happens over there.  Yes, the prices got crazy, but as long as you don't own that stuff, it really shouldn't matter.

Or should it?  China owns a lot of U.S. treasuries, and if things get really bad over there, it can cause problems around the world.  Well, we've been seeing the impact of China on the commodities markets over the past few years.  That's certainly a big deal.

So I've been thinking about that, and this is a movie I've seen before.  The same exact thing seems to be happening as when the Japanese market topped out in December 1989.  Now, that was a bubble.  I'm not saying China isn't or wasn't a bubble.  It sure seems like some stocks got pretty expensive over there.  But it is a little confusing because the Hong Kong listed H-shares are trading at below 9x P/E or something like that.

But anyway, yeah, Japan was quite a bubble.  That one goes into the history books along with 1929, 1999, South Sea Bubble etc...   And the Chinese one may too.

Back then, people were worried about Japan taking over the world.  They were buying up trophy properties in the U.S.  By the way, did any of those investments work out?   And do the Japanese still own those properties?  Did they actually make money on them?  Or was it just a big transfer of wealth (from the Japanese buyers to the American sellers)?

When the bubble popped, there was a tremendous amount of fear.  The Japanese were buying U.S. treasuries in such huge amounts that the fear was that U.S. interest rates will spike once Japanese buying evaporates.

As you see, this is sort of very similar to the situation currently with China.  Whenever people say that if Japan (and now China) stops buying U.S. paper, we are in big trouble, I scratch my head because they will only stop buying U.S. paper when we stop shipping all our money over there (we import stuff from them, they take the dollars, come back and buy treasuries).  I always thought that the day they stop buying our treasuries will be when they don't have the dollars flowing in.  And in that case, the dollars will come from somewhere else.  In the 80's, Japan funded the U.S. deficits.  In the 00's and 10's, China did.   Maybe we will start funding them internally (excess bank liquidity etc.).   Who knows.

Anyway, I remember how resilient the U.S. (and the rest of the world) was to the Japanese bubble collapse.  Check this out.  Here is the chart of the Nikkei 225 index (blue) and the S&P 500 (red) index, both indexed to 0% at the end of 1989.

Nikkei Index versus S&P 500 Index 
(December 1989 - October 1995: change in index, excl dividends)

The Nikkei started to collapse immediately in 1990, but the U.S. market was fine.  For the record, the S&P 500 index was trading at 15.2x P/E (ttm) and the 10-year treasury rate was 7.8% at the end of 1989.  That's an earnings yield of 6.6% versus the 7.8% interest rate.

As you can see, the S&P 500 was fine despite the total collapse in the Nikkei.  The little bear market in the second half of 1990, as you recall, was when oil prices hit $40/barrel due to Sadam Hussein's invasion of Kuwait.  We all remember that, and the Baker press conference which began with "Regrettably..." or some such thing that began the war; the comment, "the skies of Baghdad have been illuminated" etc. (those events came way after the low).

This is the event, by the way, that lead to every trading room on Wall Street being equipped with televisions. During this first Iraq war, traders called their wives, told them to turn on CNN, put the phone by the TV and just leave it there.  Traders then took that 'feed' and piped it into the squawk box for all to hear (this was before you could watch TV on your computer.  Don't forget, this was the era of glowing, green screen Quotrons).

Anyway, other than that, the U.S. stock market did fine as Japan disintegrated.

We usually look at long term returns going backwards, like the five, ten, twenty year figures going backwards.

Let's look at this going forwards from December 1989 for the S&P 500 index (total return):

From December 1989:
5 years   (to 1994-end):   +8.7%/year
10 years (to 1999-end):   +18.2%/year
20 years (to 2009-end):   +8.2%/year
25 years (to 2014-end):   +9.6%/year

And just for fun, if you looked at the period from December 1989 through December 2008, which was the year-end low point of the financial crisis, the 19-year annualized return would have been +7.3%/year.

The ten year return from 1989 might be meaningless as that was the great bubble.  But if you look at the 19, 20 and 25 year returns, the U.S. stock market did fine despite the Japan crash.

I really don't know what will happen going forward, but I thought I'd take a look at this as it seems really analogous to what's going on now in China.  Of course there are a lot of things different than 1989, but it's one thing to think about when thinking about China.

Of course, this is not to say the we won't have a correction or a bear market.  I'm just looking at things, sometimes one at a time, like when I looked at interest rates versus the stock market.  There are many other factors that will impact the stock market.  And this is not to say that there won't be impact in certain places.  I think luxury goods makers took a hit when Japan collapsed.  There will be certain areas that will get hit if China falls apart (more than just the stock market).

But judging from this, it need not take down the whole world.

Great Book

And by the way, I recently finished this book by Lawrence Cunningham and really enjoyed it.  The only thought was that I wished it was a longer book.   This is the first time I read stuff that dug deeply into the histories of the operating companies.  Some of the stuff, we've read over the years from other sources, but there is a lot here that is new to me.

For those planning on holding Berkshire Hathaway post-Buffett, this book is a must read.

Check it out!


  1. Great article KK - the comparisons with recent fears of China taking over the world to fears that Japan was taking over the world are spot on ( If you recall the 1987 movie "WallStreet"with Mike Douglas, he talks how everyone was studying Japanese).

    I have a quick question - are the returns on S&P 500 total returns including dividends?

    Best Regards,

    Dividend Growth Investor

    1. Thanks. Yes, it is very similar. Of course, in the case of China, it is possible for them to actually take over the world with a population of 1+ billion versus the tiny (and shrinking) Japan.

      The returns in the table are total returns including dividends. The chart is just the index levels, though.

    2. Thank you for your response. The only reason I asked about returns is because of the chart.

      On a side note, do you know where I can find historical annual earnings and dividends information on Nikkei 225, going back to 1970s or 1980s?

    3. Yeah, that was not clear. I am going to add a comment about that. Thanks for pointing it out. And Nikkei data? Hmmm.... actually, I have no idea. I'm not really good at this data stuff. I'm only realizing how much stuff is out there in terms of API's and whatnot from various sources. I am a total beginner when it comes to that.

      On the other hand, Nikkei is owned by the Japanese newspaper so I wouldn't be surprised if the data is NOT floating around out there for free... They are very revenue oriented for that sort of thing, like S&P too (but we get that stuff somehow indirectly).

      The other sources for Japan stuff are MSCI and FTSE, and I would imagine there stuff to not be free too... of course, Bloomberg too...

    4. sheesh... I meant "their stuff not to be free either", lol.... summer hibernation of brain cells....

  2. This is by-far my favorite finance blog, and I want to support it. So I always try to buy books in your amazon store. Unfortunately, it does not allow me to choose the Kindle edition. If I follow a link from your store to Amazon, will you get credit for a purchase? Or is there a code I can enter for The Brooklyn Investor? If not, how about a PayPal account? I am sure I am not the only one who wants to show thanks for your quality insights.

    1. Hi, thanks for the nice words and support.

      I have yet to figure this out. Every time I link a book, the page that I am looking at shows all options on the book; kindle, hardcover, paperback, used etc... But for some reason, when I go look at it at the store, only one version is there. Maybe if you just click on it and then change the item in the store before checking out works. I don't know.

      In any case, here is the link to the kindle version which I added to the store. I would rather not have multiple listings of the same book, so I will do some research and figure this out.

      Thanks for the support.

    2. that link worked. thanks. a PayPal link on your page would not be a bad idea either.

    3. Hi, thanks for the thought and support. This isn't a commercial enterprise for me at all, but I have always been curious about Amazon's associate program so I put some banners on the blog for special promotions. I have no idea if anyone really gets better deals, but check it out. If you click on the banner and make a purchase through it, presumably I get some credit.

    4. FYI, it looks like your readers do get a better deal. Thru your link I paid $15.65, while the normal Kindle price was $17.65 when I went directly to Amazon.

  3. Honestly, I don't think China's stock market will reach 4,000 points in a short-term basis...

  4. I am uncertain if the Chinese reblanced the reminbi in response to QE/stimulus/devaluation causing their currency to appreciate vis-a-vis the developed world, or the internal flight to reminbi following stock market sell-offs (causing the currency to appreciate). Probably a combination of both.

    I am not sure where or when all this wordwide QE/stimulus/devalution leads. But I fear we have not seen the last termors.

    "宁为太平犬,莫做乱世人" (nìng wéi tàipíng quǎn, mò zuò luànshì rén) which can be translated as "Better to be a dog in a peaceful time, than to be a man in a chaotic period." Which I like better than "May you live in interesting times.

  5. Hi KK,

    At the current situation in the market, US/China stocks have fallen quite a bit. What type of possible bargain buys do you see in the current selloff?


    1. Hi,

      Well, everything is down so whatever you liked last week is cheaper now. Also, I am updating the superportfolio rankings today so go check out those pages (look at the "pages" section of this blog), and I plan on updating the screens every day if we keep going down like this.

      If the market keeps going down, things can get interesting and fun, as long as the stock market doesn't start to feed back negatively into the economy, which is of course possible.

      But I tend to see this more of a 1997-type situation than a Nikkei 1989, U.S. 1999/2000 or U.S. 2008/2009 situation. Which means that basically, it's a blip (and maybe a temporarily painful one) and time to look hard at what you own and if you own good, solid companies with good managements, it won't matter; things will be fine in the longer term.

      But that's just my opinion which is no better than anyone else's, lol...

      I was actually hoping for a real "crash" as Black Monday was before my time so although I've experienced slow-motion crashes (Nikkei 1990-1992, S&P/NASDAQ 1999-2002, S&P 2007-2009), I've never actually experienced a real one-day crash... I was actually hoping for one this morning.

      I know it's dangerous to hope for such a thing as it may actually start a negative feedback loop and be real bad for everyone (including me), but I don't know... I still wanted to see history up close, lol... Talk about irrational.

    2. Thanks for the Reply.

      I too would wish for a crash if i had a lot of cash on hand. But as of now i am fully invested in stocks. I am debating to trade off some of my less down stocks for more beaten ones but it may be a bit premature for that.

      Actually, since we are on this topic, i would like to know if you are fully invested in stocks right now. If you are not, then why not? And if you are fully invested, do you just want to see a big crash just for the fun and giggles? :)

    3. Yes, pretty much. I do have some shorts; mostly the really egregiously overvalued stuff. But not enough to offset any real crash or bear market at all.

      But the reason I don't worry too much is that the stuff I own is the boring stuff I always talk about here. If I was long a bunch of Netflix, Amazon and Apple, for example, then I would be really, really worried. But I don't own any of that stuff...

      So my thinking is that in a crash, all stocks would go down a bunch for sure, but when things stabilize and normalize, the stuff I own would hold their value (i.e., bounce back quickly after the panic subsides).

      This may not be true for a lot of the real bubble stocks.


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