The Valor Blog.
Investment News and Views, Direct from Our Team.

25 Trillion Good Reasons…

A ¬†friend of mine Rai Thistlethwayte has a hit song called “20 good reasons”. I was thinking of doing a cover and rewording the lyrics to highlight the break up that Australia is about to go through with its economic love affair with China.

The new song will be called “25 trillion good reasons”. China now has approximately $25 trillion in debt. $15 trillion in the last 5 years (Borrowing the entire size of the US economy in 5 years). The breakup scenes in Thirsty Merc’s video may resemble the break up pain that Australia is about to go through over the coming years.

I find it slightly comical that the journalists keep mentioning that China is going to stimulate their economy. I ask the question, how is $15 trillion dollars in the last 5 years not a stimulus? How are they going to improve on $15 trillion in 5 years? Are they going to double the stimulus and borrow $30 trillion in the next 5 years to keep growth at their magic number (which appears to be more of a ‘guestimate’ than a hard figure). With credit efficiency now at closer to 20%, to make a 7.5% growth target they will need to borrow at almost 5 times this rate at around 35% to 40% of their economy per year. Unlikely!

We remain very allergic to the “China Growth Story”.

The question we are unable to answer is what are the likely flow on effects to the rest of the Australian economy? We know that housing is now 3.4 times the size of the economy. This is worse than Ireland in 2007 and getting close to Japan in 1989 which topped out at 3.8 times the size of their economy. If unemployment rises rapidly due to a significant slowdown in China, Australia may have some difficult times ahead. The average punter I speak to has a portfolio of miners and banks. Our valuations on these sectors is that they are closer to double their fair valuations based on long term reversion to the mean. The secret to creating wealth is to avoid losing money. I would suggest that investing in miners and banks is the opposite to Buffett’s rules:

Rule Number 1: Don’t lose money

Rule Number 2 Don’t forget rule number 1.

Those that are patting themselves on the back for wonderful investing due to owning 40% of their portfolio in banks at present should heed the lessons of Bill Miller. Bill Miller was the poster boy of the investing world up until 2007. He bet big on banks. He lost nearly 75% of his clients money in 2008, wiping out over a decade of profits. The lesson of Bill Miller should be drilled into investors, however the great majority of Australian investors believe that it is different here. They are actually correct. It is different here. Our housing bubble is approaching twice the size of the US bubble when measured against GDP. The US only got to 1.8 times the size of their economy in 2007 and we are currently at 3.4 times. There are 25 trillion reasons that now is not the time to do a Bill Miller!