Bad Moon Rising in the East May Be Trouble For The West

by Richard Band | September 2, 2012 9:00 am

Investors are fixated right now on Jackson Hole, and Ben Bernanke’s speech.  (The Dow fell 107 points on Thursday reputedly on fears that Dr. Ben might be vague about any new Federal Reserve “stimulus” plans.)  But trouble is brewing elsewhere, almost 7,000 miles from Wyoming.

I’m talking about China.  The big news this week — although it barely merits a footnote in the mainstream media — is that the Chinese stock market is plumbing multiyear lows.  Indeed, the benchmark Shanghai Composite Index[1] closed Thursday at its lowest ebb since February 2, 2009.

In other words, Chinese stocks have wiped out all their gains (and then some) since the major bottom on Wall Street, which occurred in early March 2009.

Something is rotten in the Middle Kingdom.  China’s industrial complex is slowing dramatically[2], a dark omen both for commodity prices and for economic growth in countries that produce large quantities of raw materials.

Australia, as one of China’s prime commodity suppliers, will feel the pinch.  I’m not too worried about Australian bonds, because they would likely increase in value (interest rates would drop) if the local economy slipped into recession.  Stick with Aberdeen Asia-Pacific Income Fund (NYSE:FAX[3]).

However, Australian stocks wouldn’t take kindly to a business downturn[4].  The three-month-old rally in the Sydney bourse appears to be peaking (see chart[5]).

Accordingly, I now advise you to sell iShares MSCI Australia Index Fund (NYSE:EWA[6]), one of our Niche Investments.  Since my initial recommendation in the February 2009 newsletter, EWA has rolled up a stellar total return (dividends plus price gain) of 130%.

What about high-yielding Westpac Banking (NYSE:WBK[7])?  Thanks to WBK’s exceptionally generous dividend, which works out to a current yield of 6.6%, I think you can hold this Cash Gusher a while longer.

Don’t get too comfortable in your seat, though.  If the Australian stock market continues to lag New York in September, we may head for the exit.

At home, I’ve had several inquiries from readers about Warren Buffett’s decision to close out Berkshire Hathaway’s (NYSE:BRK.A[8], BRK.B[9]) municipal credit-default swaps.  It’s hard to interpret this move other than as a reflection of Buffett’s concern about the deteriorating financial health of many state and local governments.  Despite his “America’s best days lie ahead” boosterism, the Sage of Omaha’s actions speak louder than words.

At the same time, I don’t think Buffett is necessarily telling us to expect a tsunami of municipal defaults.  His main goal in closing out the swaps was probably to reduce Berkshire’s exposure to leveraged derivatives — “financial weapons of mass destruction,” as he once called them.

Bottom line:  Hang on to your municipal bonds and funds.  But keep an eye on the states of California and Illinois.  (On Wednesday, Standard & Poor’s downgraded Illinois’ debt rating[10] a notch, citing the state’s failure to enact pension reform.)  If an epidemic of defaults were to grip the nation, it would most likely start in one of those two states.

P.S.  As foreseen in Tuesday’s blog, Pembina Pipeline Corp. (NYSE:PBA[11]) dipped briefly to our $27 buy target today.  Coca-Cola (NYSE:KO[12]) almost triggered our $37 buy signal.  Use limit orders, good till canceled, to boost your odds of capturing our preferred price for these and other stocks.

Endnotes:
  1. Shanghai Composite Index: http://finance.yahoo.com/q/bc?s=000001.SS+Basic+Chart
  2. industrial complex is slowing dramatically: http://in.reuters.com/article/2012/08/29/us-china-economy-pmi-idINBRE87S05M20120829
  3. FAX: http://studio-5.financialcontent.com/investplace/quote?Symbol=FAX
  4. Australian stocks wouldn’t take kindly to a business downturn: http://investorplace.com/2012/08/australian-banks-are-the-big-yields-worth-it/
  5. chart: http://profitableinvesting.investorplace.com/wcmedia/AORDS_8-29-12.png
  6. EWA: http://studio-5.financialcontent.com/investplace/quote?Symbol=EWA
  7. WBK: http://studio-5.financialcontent.com/investplace/quote?Symbol=WBK
  8. BRK.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.A
  9. BRK.B: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.B
  10. downgraded Illinois’ debt rating: http://www.chicagotribune.com/news/local/ct-met-quinn-credit-rating-20120830,0,4796847.story
  11. PBA: http://studio-5.financialcontent.com/investplace/quote?Symbol=PBA
  12. KO: http://studio-5.financialcontent.com/investplace/quote?Symbol=KO

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