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Jubak's Journal Recent articles: • 5 stocks fired up by energy mergers, 12/14/2005 • 5 big 'ifs' investors face in 2006, 12/13/2005 • The U.S. -- not Japan -- is the place to invest, 12/9/2005 More... | Jubak's Journal 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 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." Related news and commentary on MSN Money 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. So when it comes to solutions, the Beijing government has only one option: provide a rising tide that will lift all boats. To stay even, China will have to create 300 million new jobs. To make a dent in rural poverty, it will have to do even better than that. And to stem the protests, these jobs will have to provide enough pay to raise income for the 700 million people in China earnings less than $2 a day. Think the Chinese government has a vested interest in economic growth? The Beijing government will undoubtedly fudge the numbers to show that growth isn't out of control in order to reassure the international capital markets. But every act of domestic violence in China is one more argument for more growth now and worry about the consequences later. That's why projections from international organizations such as the Asian Development Bank and the International Monetary fund that call for 8.8% growth in the 2006-to-2007 fiscal year are more likely to be too low than too high. China isn't alone in this problem. India will add 71 million workers to its population in the next five years. The country already counts 38 million official unemployed. Tens of millions more are underemployed. Vietnam is even poorer and younger than China and India. And all that's bad news for bullish investors who are counting on a combination of not-too-high-and-not-too-low growth with steady or declining commodity prices to deliver their own tide that will lift all stocks in 2006. Updates Sell Komag Komag shares hit my February target price of $36 on Dec. 2. Quite frankly I've been waiting around to see if the stock had more legs before cashing in. But with the stock looking like it has topped out for the moment -- and since I think we could see a wave of end-of-the-quarter profit this quarter, as we did at the end of the September -- I'm going to take my profits here. It's been a wild ride since I added these shares to Jubak's Picks on July 8, 2005, with the shares climbing as high as $40 before crashing to $25. In this case it paid to hang on -- the position shows a final gain of 17%. As always, the problem for investors is figuring out when it pays to hang on and when it pays to take your losses. (Full disclosure: I will be selling my personal position in Komag three days after this column is posted.) Buy TOTO Business conditions and confidence continue to improve in Japan, so I think it's time to add a company that will prosper from the recovery of domestic consumer spending in Japan to my positions that emphasize that country's export boom. TOTO, which trades as an ADR (American Depository Receipt) on the U.S. over-the-counter market, is the largest maker of bathroom fixtures in Japan with a 60% share of the market. (The company also sells its high-end products internationally.) I think investors can see the beginnings of a recovery in the domestic economy as a result of the export boom in the Bank of Japan's Tankan Survey for December. The gauge of the percentage of companies reporting that conditions are better (minus those reporting they're worse) rose 2 percentage points to 21. The survey further showed that Japan's corporations on average expect to increase their capital investment by 9.1% in the fiscal year that ends in March 31, 2006. In September, that figure stood at 6.8%. That's good news for TOTO, which depends on the Japanese building and renovation sector for the bulk of its sales. As of Dec. 16, I'm setting a target price of $105 a share by December 2006. New developments on past columns Time is ripe for these 7 biotechs Positive news from clinical trials has sent shares of Cell Genesys Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Cell Genesys and Komag. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||
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