Chinese "core belief" of "anything not expressly permitted is not permitted at all" may pose challenges ahead

Rich Karlgaard 05.07.07, 12:00 AM ET

For every Chinese entrepreneur like Alibaba's Jack Ma (check him out on Wikipedia), there must be 10,000 who fear sticking out, bucking authority or going off-script. You see this everywhere. One afternoon at the Shangri-La, my wife, kids and I decided to abort a long elevator wait and take the stairs. Up we trudged to the 13th floor--they have 13th floors in China--but on the 12th we were met by a startled hotel employee. He nearly passed a brick seeing us on the stairway. He shouted for us to walk back down.

"Just one more floor," we begged. "Down! Down!" he shouted.

Another anecdote among several: One night the hotel left a complimentary bottle of wine in our room. We took it to dinner in a hotel restaurant. This confused the waitstaff no end. Four or five of them consulted frantically. Finally, their leader stepped forward to say that bringing the bottle of wine was "not permitted!"

"But it's a gift from the hotel," we protested.

"Not permitted," repeated the waiter. He wasn't angry. He wanted to do the right thing, but he was afraid. You could see it in his eyes.

Perhaps my Western eyes see this unfairly, but it seems to me that 99.99% of Chinese wake up each day with a core belief: Anything not expressly permitted is not permitted at all.

But that's most of life: Not permitted! Ask yourself: How far can China really go if "not permitted" is the default mental mindset of the country's vast majority?

Maybe this won't be a key question during the next 10 years. China has so much catching up to do it can easily grow 10% a year for another decade. Crunch time, I think, will come in the 10- to 20-year time frame. Unless attitudes change, that's when the "not permitted" mental default will begin to slow China's incredible march forward.

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Cheap money means either higher stock prices or higher interest rates

Rich Karlgaard 05.21.07

Ken Fisher, fellow FORBES columnist and founder of a $39 billion fund, would never predict an 18,000 Dow. That's only because Fisher hates using the Dow as a reference. But he does say U.S. stocks are undervalued by about 40%.

"We live in a unique period of history," Fisher recently told attendees on the 11th FORBES Cruise for Investors. "All around the world earning yields--flip P/E to E/P to gets earnings yield--are higher than ten-year government bond yields. For the American S&P Index the E/P is 6.7%. Compare that to the cost of borrowing. The average S&P company can borrow money at 5.8% pretax, or about 3.8% aftertax."

Call it the Fisher Spread. It's nearly three points. Historically huge.

The Fisher Spread leads to Fisher's calculus: S&P Index companies borrow money at an aftertax average rate of 3.8% to buy back their shares, which, on average, are yielding 6.7%. It's no surprise that companies are buying back their shares. (Globally, the Fisher Spread between E/Ps and ten-year government bonds is even wider.)

Private equity firms play the same game. In fact, they play it better and more aggressively. That's their sole purpose. By smartly playing the Fisher Spread, private equity firms can't lose in these conditions:

If the stock market goes up--thus narrowing the Fisher Spread--the private equity firm can take its companies public. If the stock market goes down--thus expanding the spread-- the private equity firm can mark up its companies and sell them to other companies. "This game will continue until the earnings-yield/bond-yield gap closes," says Fisher. That is, when the Fisher Spread ceases to exist. When it ends, it will end badly. Companies will fail to grasp that the Fisher Spread, not CEO genius, makes acquisitions work. Private equity firms will become overextended and go bust. But for now--and likely for another 24 to 36 months--the case for buying stocks has never been stronger. link

Risk, returns, and labour arbitrage

-How much risk you are willing to take will determine how much gains you can make (if you don't know what risks you are taking you're in trouble).

-Since you're job (and more broadly your country's economy) is probably competing with one in China or India or elsewhere, eventually your salary is going to go down. You should invest your temporarily higher income so that you will benefit, not lose, from this transition.

Professional Money Managers Have Other Priorities. However, You Need Time To Manage Your Own Money

Being real about it, one of the reasons why it's possible to beat professional money managers is that their priority is not making you money. First they want to make themselves money, secondly they don't want to do anything that would be seen as outlandish (therefore they need to remain within the bounds of traditional thinking), and thirdly they are handcuffed by rules and regulations.

Of course, in order to actually beat these guys you need to have at least $1500 to invest, a lot of patience, and enough time to spend learning the ropes, gaining an understanding of what causes what and what's going on, and staying aware of what's changing. If you can do this, or if you can get someone else to help, in my opinion you can do much better for yourself. For example, I've been doing this for almost five years now, and I've averaged 20% per year in Canadian Dollars (almost 30% in US Dollar terms because of the fall in value of that currency). Of course, the market has been going up (and that's the best time to learn the ropes- when your mistakes can be hidden by a rising tide), but compared to your average mutual fund... I'm doing three times as well. In fact, the most widely held funds have single digit returns in the last five years (as I recall).

According to the table below, the returns are slightly better. However, this makes things look better than they are because the most widely held funds now are usually the most widely held funds because of recent performance (they are invested in after the good returns came, not prior).

Large funds: These funds have the most assets under management in all categories *

Company	Net Assets	1-year	3-year	5-year
American Funds Grth Fund of Amer A	83.87 Bil	11.02	12.84	10.84
American Funds Invmt Co of Amer A	73.62 Bil	15.06	12.03	9.38
Vanguard 500 Index	70.35 Bil	16.05	11.39	8.60
Fidelity Contrafund	68.71 Bil	10.66	14.44	12.19
American Funds Washington Mutual A	67.82 Bil	17.81	11.54	8.61
Dodge & Cox Stock	67.56 Bil	16.59	15.85	13.74
American Funds Capital Inc Bldr A	65.66 Bil	20.25	16.17	13.11
American Funds Capital World G/I A	64.47 Bil	18.98	20.28	17.16
American Funds Inc Fund of Amer A	61.81 Bil	19.25	13.50	11.36
American Funds EuroPacific Gr A	56.23 Bil	16.04	21.22	16.65

* Performance numbers for periods greater than one year are annualized. Excludes mutual funds closed to new investors.

http://moneycentral.msn.com/investor/partsub/funds/topfundresults.asp?View=Large&Category=All&Symbol=$LRGF

"U.S. Corporate Earnings: Global Boom Provides An Offset To Soggy Domestic Profits"

U.S. earnings growth continues to decelerate, but the weak dollar and strong global economy imply no contraction ahead.

Corporate earnings growth has been steadily slowing in the past several quarters, and prospects are for further soft results ahead given that the economy is still growing at a sub-potential pace. On the positive side, the weak dollar is providing a lift, particularly since it has occurred at a time when global economic activity has been strong. Overseas profit growth lagged the domestic upturn in recent years, but is now a source of strength. While foreign profits are only 17% of total profits based on the government’s national accounts measure, they comprise a larger slice of the S&P 500 profits. Thus, while corporate earnings will remain the weak link for equities as long as the economy stays soft, we do not foresee a contraction in profit levels that typically coincides with a significant market decline.

http://www.bcaresearch.com/public/story.asp?pre=PRE-20070425.GIF

A few things that help (in my opinion) to beat the market

A healthy distrust of common beliefs and traditional dogma

Curiosity as to what affects markets

A lot of time to spend learning

Patience

Knowledge of what you don't know

Chinese and US domestic economies inversely correlated

Well, up to a point; but in the other main scenario, a global recession, you should have gold. So if you're bearish on the US domestic economy, go with the China, or vice-versa.

http://www.bcaresearch.com/public/story.asp?pre=PRE-20070405.GIF