HK's future

HK really has to think hard to find its right place in a more open China, instead of waiting for Beijing’s implicit subsidies. Otherwise it would lose its future pretty quickly. The 20 some percent high school graduates entering college is extremely low and the 20% poverty rate is extremely high. The future might move past HK pretty quickly.

But the tycoons do not care, as long as they can keep paying no taxes on capital gains, from which they draw most of their income, while charging high prices on everything in HK, from which they make a lot of money.

• HEARD ON THE STREET
• Updated April 11, 2012, 12:02 p.m. ET

China Gets in the Zone for Luxury

By LAURIE BURKITT And TOM ORLIK

China's government departments are locked in a battle over whether to cut the country's luxury tax.

The Ministry of Commerce wants to drop a roughly 30% tax that drives shoppers to Hong Kong and Paris to buy their Prada handbags and Chanel sunglasses. The Ministry of Finance is suspicious of a plan that threatens to lower tax revenue. The outcome could be a boon for the luxury brands themselves.

One possible compromise is the creation of special luxury zones— urban centers where the normal high taxes are lowered. If that plan gets off the drawing board, the big loser would be Hong Kong, where mainland shoppers arrive in droves to take advantage of zero luxury taxes. Around 28.1 million arrivals from China made up more than two-thirds of the visitors last year.

Inbound visitors spent about 253 billion Hong Kong dollars (US$32.6 billion) in 2011, equivalent to 13.4% of gross domestic product. Queues of mainland shoppers outside Hong Kong's most expensive stores testify that a big chunk of that spending is from luxury tourism.

As a style center and shopping hub, Hong Kong is akin to China's New York. But losing its price advantage over mainland cities would hurt its retail sector. A downturn in luxury shopping trips from the mainland could have a meaningful impact on hotels and airlines as well.

The big winners would be the luxury companies. To be sure, the big brands have already established networks of stores in China, so a change in the tax regime wouldn't necessarily make luxury goods physically more accessible for Chinese consumers. Aaron Fischer, luxury expert at CLSA, downplays the impact of relaxing the tax laws. Chinese demand for luxury goods hit $46.9 billion last year, of which $27.1 billion was spent abroad; the main impact of lowering taxes or creating luxury zones would be to drag some offshore sales onshore, Mr. Fischer argues.

Still, the creation of luxury zones on the mainland would bring luxury goods closer to home for parts of China's rising middle class that don't want the hassle and expense of a trip to Hong Kong. More importantly, lowering the taxes gives the luxury houses an enviable choice for ratcheting up the profitability of their mainland businesses. They can lower prices and generate more volume or keep prices high and reap higher margins. Either way, they win.

 

Write to Laurie Burkitt at laurie.burkitt@wsj.com and Tom Orlik at Thomas.orlik@wsj.com

Investment and Entertainment

Most investors equate investment to entertainment to some extent. Many, like the retail investors who have no information (e.g., my dad), invest purely for the entertainment. This is a severe behavior bias that we all need to guard against.

In the last couple of months, there are friends who ask me when I would advise them to sell, especially when they do not see I post anything. They are always itching toward the next trade. There will be people who would regard low portfolio turnover as being slacking on managing money for them. This happens even to many institutional investors.

There will also be people, who have MBA degrees from great schools and work for big banks, argue that they are still unclear what to do when they see my posting on risk on and risk off. Some of them also argue that my postings are not a track record because I do not tell them exactly what to do. Well, the simplest thing would be to buy or sell a Heng Seng index ETF, mutual fund, or futures contract. It cannot be easier. If one wants to spice up the trade a big more, bringing in high beta stocks and long term US treasury bonds or bond ETF, mutual funds, or futures contracts. Since some of these friends are managing money for other people, I think their clients should be really concerned. If these friends are so lazy to even think of these, they probably should give their clients’ money, plus their own money, for me to manage.

Investing should really be emotionless. Ups or downs, right or wrong, it should not affect your mood and behavior. This takes some experience to achieve. Good luck in getting rid of the entertainment aspect from your investment.

It is time to lighten up risks

I meant to post the day after ECB’s second LTRO to post this update but I was too busy. Four seminars of three papers in three weeks are a killer and I am still digging out of the hole due to the travels done in the three months till early February.

So what has changed? 1) ECB finally answers to the call of duty to its lender of the last resort responsibility and the risk of imminent breakup of Eurozone is greatly reduced. But ECB does not have clear plan for more large scale QEs unless things gets much better. 2) Bernanke announced the same intention in the last few days. The US first quarter GDP estimate consensus is likely to be revised down slightly. The US corporate earnings have peaked out. If it were not due to the blowout profit from Apple in the last quarter, corporate earnings would have pivoted then. 3) China will not loosen up as much as people have expected (of course they have always yielded to pressure of economic slowdown every time in the last ten years, which finally leads to the current dire situation).

On the eve of ECB’s second LTRO, the market has priced in all the great news (and likely more than the realistic level). Now some of the good news has not come as much as expected. So the market is a bit disappointed and is consolidating. It might still go up in more volatile environment than in the last three months but the risk has started to overweigh the return. The further gains can only rely on investors’ unrealistic overreactions to good news.

Is this a good time to set up shorts or buy long term T-bonds? I would wait at least another couple of weeks to examine the situation. Likely the biggest potential bomb is disappointment in earnings, which would happen after April 1. Even then, one has to see how much a correction it will be, if any.

When to set up the same trade that I described to start on Jan 1 last year for last year

Since I have been telling people about a potential rally in risky assets from last December that could last till the end of the February, due to the temporary extension of US payroll tax cuts to the end of February, the best time to set up the trades that I mentioned as performing extremely well last well may be some time close to the end of February, unless some disaster in Eurozone erupts. Also, if the US Congress extend the same cuts longer, the markets could have even longer a relatively calm period.

Is there anything to do in the meantime? Are those trades the only thing one can do by believing my longer term predictions? Yes, of course. Plenty of them. As I mentioned a few times in the past, "Only the complacent lazy investors, which is the majority, hope for bull markets to make money."

Who is the most novice investor I refer to in my prior post?

My dad. He is about 75 and a retired professor. He has gambled invested in Chinese stock markets for a long time but I do not think that he made any money from this effort. Throughout 2011, I strongly urged him not to invest in stocks but put money in the highest interest yielding saving instrument he could find or Chinese T bond. Since I have not been back to mainland Chinese for almost six years now, it is difficult for me to check his actions. But I did learn that he is not heeding my advice even if I have been trying all the means to rein him in. When I finally met him this last December, he has lost a decent sum this year, instead of making money if he has followed my advice. It made me realize how biased human behavior could be. Even though it does not mean you can necessarily make money from market inefficiency, the markets are surely not efficient, to the smarter minds!

Review of 2011 and Preview of 2012

Everyone is writing a review of 2011 and a preview of 2012. So I am obliged for one as well. How do my predictions fare this year? Here is what I predicted to be happening in the next five years since late 2010.

n. China will face sharp slowdown in growth in five years (say from 10% to 3%) for many years to come

Review: So Chinese stock market started from around 2800 and reached more than 3000 and ended at around 2200. Chinese property prices (new housing only) are reported to have dropped as much as 20-40% from peak in big cities like Beijing and Shanghai.

n  Related emerging markets and commodity producers will suffer as well.

Review: The starting and ending points of some of the representative countries are: Argentina 3600 to 2400; Australia 4800 to 4100; Brazil 70000 to 57000; Russia 7000 to 5700; Note that for many of these countries, the returns would be much worse on USD terms.

n  HK’s housing price will drop substantially

Review: HK’s housing prices have already dropped by about 10-15% from peak. Its situation will be somewhat better than mainland given that its substantial wealth fund and mainland outflows may cushion some eventual fall.

n  Chinese people may not suffer in their satisfaction

Review: Although I do not have the wage growth numbers yet, but this may be the first year in a long time that Chinese wage growth is far greater than GDP growth.

n  The world will not come to an end with the slowdown in China’s growth

Review: We still have to wait for this one in a few years of time, given that China has just started the first bout of real slowdown.

n  Eurozone will not survive in the current form

Review: Stoxx Europe 600 dropped from 285 to 240. Euro dropped substantially (though Germany has strong incentive to keep Euro in the hopes that other countries would still repay their debt in Euros, which may make Euro / German Mark a strong currency eventually given Germany’s export prowess).

n  The U.S. will become stronger in relative terms if it can get the political act together

Review: SP500 dropped from 1280 to 1260, the least drop probably among any of the larger markets.

Market timing review (only turning points):

April 10: Predict deflation scare later in the year, Hang Seng at 24k

August 4: Deflation scare is in full force, Hang Seng at 22k

October 12: Bear rally, Hang Seng at 18k

November 9: Italian job, Hang Seng at 20k

Currently, Hang Seng at 18.5k

My guess is that people are far more interested in 2012 previews. So here they are. But remember whatever you fail to act on my advice is real money left on the table by you. So think about that when you are trying to decide about the new year. The longer term themes will play similarly like 2011, though as usual large volatility is guaranteed.

US likely will outperform in terms of economy. As I mentioned in earlier posts, I envision the US may be much better in 2013. However, recently Obama has finally become less ineffective and his narrative is cornering Republicans who are fighting for the primary right now and thus have more chance to split and criticize each other. Republicans will have a hard time because Obama does not need to be really effective to turn the table on them. For example, it is difficult for them to reject tax increases on the rich while also rejecting payroll tax reduction extension for average Americans. So the recession risks in the first quarter would be much smaller than what I assessed before. Unless Europe really has its tailspin, and maybe we have a simultaneous big negative shock in China (which may still be unlikely given that this is the last transition year), then the US may be pushed straight into recession. Otherwise it may still have zero or positive growth.

Europe will finally have one or two small periphery countries defaulting (and maybe simultaneously leaving Euro zone). The final outcome for larger countries like Italy and Spain may still be delayed into 2013 or 2014. Pay attention to the refinance funding hump around March. So some rallies may happen at the start of the year, due to encouraging US data, only being crushed at or around March.

China is crippled. It will not have enough powder to ignite yet a huge bubble and many have finally come to terms with how insurmountable are the issues related to China’s imbalanced growth. But it is unlikely to have GDP growth collapse this or the next year. The first trick the government would try is to speed up the low income housing projects. But that is unlikely to make up the hole left by the current boom in commercial and high end residential real estate. Then the government may yet revert back to the prior real estate booming sectors again, because unless a crisis already crushed a big section of the economy, the least politically difficult path is to keep the status quo and the leadership is unlikely to start to solve the root cause of the problems in China.

Many of the commodity exporters and emerging markets would still have enough powder to survive a couple of more initial shocks in the next couple of years. But in the longer term, they will also experience a regime change in terms of their growth.

So in conclusion, the world has grown in relative peace and prosperity under the current model for 20 years. The resulting imbalances, in particular the imbalanced growth between US and China and between core and periphery Europe and the sharply increased wealth disparity in most parts of the world, are being pushing to extreme. Most people have false hope that the world could yet quickly revert back to its prior growth trajectory after a brief financial crisis in 2008-2009. What they fail to realize is that until these imbalances are resolved, the forgone prosperity won’t come back easily. Yet no adjustment to resolve the imbalances is painless.  What the world is currently suffering from is the pain due to these adjustments. So for people who are interested in the end of this painful period, remember that until all the painful adjustments are done to the issues that I pointed out above, we won’t see the end of pain. We are only partly through the adjustment in Europe, whose internal imbalance is small in comparison to that between China and the US, and this latter imbalance is just starting to be resolved. In this environment, taking the appropriate asset allocation strategy will avoid you sharp losses and leave you far ahead.

Unfortunately, among the people or funds that I know or read about, I still mostly see confused souls that have no correct sense of direction. This is not surprising given the deeply seated human behavior bias of overconfidence and the general ignorance of the dominant majority of investors, including professional investors. Even some of the most novice investors I have met could still be so convinced that they are going to do much better than the market and the rest of people. This is not because I want to pull ranks or past prediction record because I strongly believe the extent of a person’s understanding of the world cannot be measured by his/her rank, position and title, mathematical and programming and writing skills, the length of experience and age, or past track record (even though the society is in general much more prejudiced and ignorant on this aspect). Maybe they should learn to ask for my help? After all, if my blog is a valuable information source, it should not be free forever. Well, time is what is in the short supply here.