The Four Trillion Yuan ($586 Billion) Tell--Or Just Noise

In a posting December, 2008 I discussed how a counterintuitive event, like a "tell" in gambling, can have predictive value.
For example, suppose a company reports worse than expected earnings. Given that news, one would expect the stock to decline. If the stock goes up in the face of disappointing earnings, that is counterintuitive, and probably means the stock is in a bullish trend.

I mention this because Bloomberg News two days ago mentioned that "The China Business newspaper reported on its Web site that China will announce in August a new stimulus package of possibly 4 trillion yuan ($586 billion)." Given that the Chinese economy had advanced a whopping 11.9% in the first quarter, a growth way above trend, and China is trying to rein in a crazy real estate market, I conclude that this mention of stimulus is counterintuitive. Why mention this now? And the amount of the stimulus is mind-boggling. It is roughly the same size as the program enacted during the worst of the recession. If this news item is true, it might indicate that the Chinese government is worried about a much lower economic growth near term and is preempting any stock market downdraft by announcing that it will be ready to provide enormous stimulus in that event.

So far, this story has not gained traction. Perhaps the newspaper is unreliable. Or perhaps this is a case of my overthinking--that this story is just noise, not a "tell". However, the European sovereign debt crisis with Greece, which may spread to other EU countries, has prompted some to reduce risk in their portfolios. That usually means, as Goldman Sachs put it during the congressional hearings yesterday, "getting closer to home". The most volatile portion of my financial assets is my position in the T. Rowe Price New Asia Fund. At the close Monday, I sold enough of that fund to bring my holding down to what I consider a "core" position, one to be held for five to ten years. With this sale, I have now reduced this position by two-thirds of its peak value.

Why not also reduce my position in the T. Rowe Price Equity Index 500 Fund? After all, many companies in that fund have a growing exposure to southeast Asia; and some heavy machinery producers, like Caterpillar, and many raw material producers are heavily dependent on a rapidly growing China. Good question.

On the positive side, corporate earnings during the first quarter have far exceeded expectations; and corporate outlooks are becoming rosier. We remain in the "sweet spot" of the cycle when profit margins expand and interest rates remain low. Wall Street, as is its proclivity, is raising earnings estimates and stock price targets. Money flows, which last year heavily favored the fixed income side, are now beginning to flow back into equities due to less fear of a relapse into recession, the stock market's upward momentum, and a growing distaste for bonds when interest rates are expected to rise sometime soon.

On the negative side, as we know, the stock market discounts the future; and six months from now we will be facing withdrawal of the stimulus program, the prospect of higher taxes to reduce the ballooning deficit, and higher interest rates. The S&P 500 Index, relative to NORMALIZED EARNINGS, is 15% to 20% overvalued. There is mounting bullishness and minimal bearishness among investment advisers--at roughly the same levels as last January immediately prior to a 9% correction in stock prices. However, this contrary sentiment indicator isn't yet at the extreme reading reached in October, 2007 when the last bull market peaked.

I have decided not to reduce my equity exposure to the S&P 500 Index yet. When the monthly employment report shows an increase of more than 300,000, a buying panic may ensue, which would provide a better opportunity to reduce my equity holdings to "core" levels.