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Jubak's Journal
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• 5 stocks fired up by energy mergers, 12/14/2005
• 5 big 'ifs' investors face in 2006, 12/13/2005
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Global growth means a risky 2006
China and India are likely to grow faster than expected in 2006. If that overheats the global economy, look for commodity and oil prices to spike.
By Jim Jubak
The bullish case for the U.S. stock market in 2006 rests on a hope that a large number of moving parts will each travel in the right direction -- and by neither too much nor too little.
Economic growth in the United States, forecasters hope, will be strong enough to send operating earnings per share for the stocks in the Standard & Poor's 500 ($INX, news, msgs) stock index up about 10% in 2006, but weak enough to keep core inflation below 2%. That low rate of inflation in turn will end the Federal Reserve's string of interest-rate hikes in the first half of the year. That's an absolute necessity: With earnings growth projected to slow to 10% in 2006 from 14% this year, the stock market will need the boost it would get from an end to Fed rate hikes.
Oh, and the bullish case also requires that the domestic and global economies don't grow so fast that they send energy prices spiraling higher from the current level of $60 a barrel oil.
That's a lot that has to go right if U.S. stocks are to climb much in 2006. If just this or that doesn't fall into place, investors are looking at a 2006 that repeats the "going nowhere" year of 2005.
I laid out the five biggest of this issues for 2006 in my last column, "5 big 'ifs' investors face in 2006." Today and in my next column, I'm going to take a more in-depth look at two of those "ifs." Today, I'll argue that domestic politics in the world's most-populous nations almost guarantees that global economic growth will be stronger than expected in 2006. And in my next column, I'll take a look at the likelihood that we'll see more commodity inflation in 2006.
China's choice: Repression or bribes
Investors know that domestic politics can affect the economy and the stock market. The U.S. stock market, for example, outperforms in presidential election years, and the effect is even more pronounced in the year before the election itself. According to The Stock Trader's Almanac, the year before the presidential election has outperformed the year after the election just about sixfold since 1832. And I've never met an investor who doesn't believe that the Federal Reserve is careful not to rock the economic boat in election years. What Finley Peter Dunne wrote in 1900 (in his nationally syndicated satirical column, Mr. Dooley) about another U.S. institution applies just as well to today's Federal Reserve: "No matter whether th' constitution follow th' flag or not, th' supreme coort follows th' iliction returns."
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But the United States isn't the only country where domestic politics move the markets and the economy. And in today's global economy, it may not even be the most important example. I think that honor right now goes to China, with India a close second.
And that's bad news for the bulls in 2006 because both China and India are being pushed toward higher growth next year. That, of course, raises the odds that the global economy will overheat, that commodity prices in general will climb and that oil prices, in particular, will spike again.
China has the most dangerous case of politics driving excessive growth right now, so let me dwell on that example.
China is in the midst of a terrifying political crisis. It's terrifying to the ruling Communist party, that is, because the crisis is close to growing from a local to a national one, and because the regime has really only two tools to "fix" the crisis. Repression, the preferred tool, doesn't seem to be working very well. If repression fails, the central government will have to fall back on economic bribery on a massive scale.
The most recent highlight of the crisis occurred on Dec. 6 in the farming and fishing village of Dongzhou, when peasants evicted from their land to make way for a power plant staged a nonviolent protest that was met by a massive show of force. According to the Beijing government, three peasants were killed by gunfire from security forces. The peasants put the death toll at somewhere near 20. The violent suppression of the demonstration was followed by a reign of terror in the area, which was sealed off from outside contact, as security forces searched house to house and took away an estimated 50 alleged ringleaders.
According to official government numbers, this is just one of a rising tide of protests in China. Last year, the number of such protests topped 74,000.
Left behind
Even more than the sheer number of protests, it's what links them that makes this such a dangerous crisis.
First, like many of the protests, this one took place in a rural area left behind by China's rapid economic growth. Dongzhou is only a short drive from Hong Kong, but the farmers and fishermen who live in the village represent the "other" China. A recent report from the International Confederation of Free Trade Unions (not exactly an unbiased source, but the data echoes that from other studies) found that while membership in the World Trade Organization has boosted the incomes of private-enterprise capitalists and white-collar workers, the incomes of farmers and unskilled workers have been stagnant for 10 years. About 250 million people in the country still earn less than $1 a day -- the official definition of poverty in China -- and 700 million (about 47% of the population) live on less than $2 a day.
Second, like many of the protests, this one was rooted in rampant corruption in the government and within the party. In this case, the farmers were protesting plans to take their land, without adequate compensation, for a power plant backed by outside developers and supported by local and provincial officials and party members. In addition, the plan would have filled in part of a local bay used by village fisherman.
So guess how far the villagers got when they attempted to petition the local government? A group of villagers delegated to complain to the local officials was arrested in July. The regular security forces that broke up the villagers' sit-in on Dec. 6 were joined by thugs from local organized crime groups hired by local officials and party members.
That corruption limits the central government's authority and its ability to apply repression -- unless it's willing to risk a national outbreak of violence that could shake the entire Chinese economy.
In the last decade, the government in Beijing has issued directives to the police limiting the use of force and coercion and spent millions training police in non-lethal crowd control. But local authorities often ignore those directives -- just as they ignore government edicts calling for the closing of inefficient factories and for an end to below-market-rate loans to politically connected businesses. On the local level, China's government often operates as a kleptocracy, driven only by its greed to appropriate public property for private profits.
The central government is well aware that a national policy of repressing protest, enforced by local officials (who see nothing wrong in hiring armed thugs), could result in an epidemic of violence.
The calming power of growth
The national government doesn't have the power or will to reform the system. The national authorities can stage a show arrest -- a police commander blamed for the Dongzhou violence by the provincial government has been detained -- and the authorities can promise an investigation. But no one believes that really fixes anything. Local governments and local business are full of well-connected party members. Any national leader who attempted to solve problems such as Dongzhou by reform would face a revolt from the party members who are getting rich from this system.
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