2015-05-02

Bizarro Market or Not? Baosteel Is World's Largest Steel Company By Market Cap

One of the important things to understand about the market is that it is always "right" even if it is frequently wrong. The market reflects the aggregate thoughts of the investing public, which is weighted towards the "smart money" as they have more votes (dollars) in the process. When the market behaves in a way that is contrary to your expectations, a very big red flag must go up. Either your expectations are wrong or there is something affecting the market that you haven't unaccounted for. Psychology is one important factor sometimes overlooked. In other cases, economic or financial assumptions may be flawed.

During the housing bubble and the technology bubble before it, there were bears who pointed out the market would fall, but most also wisely said you don't short a psychologically driven market. Bulls incorrectly argued there was a "new normal" or that "home prices don't fall nationally." In the run-up to hyperinflation in Wiemar Germany, the public believed the economy was booming. The stock market rally was seen as proof of the economic boom, not incipient hyperinflation.

Today, here is ZeroHedge trying to make the case for corporate buybacks as one of the few things levitating the U.S. equity market: The US Equity Bubble Depends On Corporate Buybacks; Here's The Proof.

In 2013, responding to confusion about the plunging gold price, I argued the gold market was wrong back in 2011: Gold Lied, Inflation Died. I had a few trade ideas based on my deflationary thesis:

PowerShares DB Base Metals Double Short (NYSEARCA:BOM). Volume is very low now, but it peaks when base metals tumble.

For China, short iShares FTSE/Xinhua China 25 (NYSEARCA:FXI) and be long Global X China Consumer (NYSEARCA:CHIQ).

Emerging markets should underperform Europe, since Europe has already seen several major markets decline. ProShares Short Emerging Markets (NYSEARCA:EUM) is one way to go.

Resource exporting countries and companies will likely be hit hardest: they are threatened by a stronger dollar or weaker commodity demand. Brazil and Australia are two countries to underweight or avoid. Companies without sufficient capital to fund their operations will likely go bankrupt, and many commodity producers and explorers could go bust if they have insufficient capital heading into a crisis.

More conservative plays: iShares Barclays 1-3 Year Treasury (NYSEARCA:SHY), iShares Barclays Short Treasury (NYSEARCA:SHV), PowerShares DB U.S. Dollar Index Bullish Fund (NYSEARCA:UUP), ProShares UltraShort Euro (NYSEARCA:EUO).
Most of those picks were spot on. Brazil tumbled, the euro slumped, the dollar rallied. The worst pick by far was the CHIQ long, FXI short:
As I wrote then:
Gold is not alone in signaling weakness: nearly all commodities are sending a similar signal. On top of this deflationary force, the Chinese leadership appears ready to rebalance the economy towards the consumer sector, something that will dry up demand for many raw materials. Copper faces a far darker future than gold.
So what happened? Why did China's consumer sector go nowhere? Consumer stocks such as Want Want (0151) and Tingyi (0322) are well below their 52-week highs. A mitigating factor is that these stocks are in Hong Kong, but the Chinese herd hasn't caught on to these stocks at the very least because neither experienced "the pop."

Not only did consumer stocks fail to rally, but some of the sectors still suffering from overcapacity have outperformed the A-share market. Cement has done well considering, but steel has really outperformed. China's is currently puking steel because domestic demand is moribund. The performance of the global steel industry and suppliers has been poor:

Yet while SLX is down 20%, Chinese steel companies have double and tripled:

Bloomberg: China’s Baoshan Catches Nippon Steel as Most-Valuable Producer
“Baoshan has an edge over steelmakers in Japan where auto production won’t grow at a pace seen in China,” said Yoku Ihara, who runs Japan’s Growth & Value Stock Research. Baoshan is one of the few Chinese producers that can supply high-end sheets to automakers, making it the “best positioned among so many Chinese suppliers, most of which make construction steel,” he said.

The China Association of Automobile Manufacturers projects domestic vehicle sales to increase an average of 5 percent to 10 percent a year, with sales last year of 23.5 million units. Japan’s new-car sales rose 3.5 percent to 5.6 million units in 2014, data compiled by Bloomberg show.

FT: Steelmakers braced for China slowdown
On Monday, The World Steel Association, the industry’s main international body, said it expected global steel demand to be largely flat in 2015, at about 1.54bn tonnes. Demand growth will then increase slightly next year, to 1.4 per cent.

“We are releasing a restrained growth outlook for the global steel industry mainly due to the deceleration in China,” said Hans Jürgen Kerkhoff, chairman of WSA’s economics committee.

My default assumption is the Chinese stock market rally has been indiscriminate or that the rally may be a precursor to currency devaluation. Stanley Druckenmiller has voiced the next best explanation China Stock Gains Signal Economic Recovery.

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