We have written fairly extensively on China over the past few years. Perhaps more important than other reasons, we pay a lot of attention to China because:

- We are likely to make more money there than the US in the next few years.

- China is likely to show large market moves ahead of the US.

- We owe them a lot of money, so if they decide to sit on the sidelines for 1 treasury auction, all hell can break loose.

China has been a very volatile place to invest and will continue to be. The main forces / sources of volatility this year may be attributed to :

- the huge stimulus

- the reflation of a property and stock asset bubble

- China in US treasury auctions

- 3 significant Chinese anniversaries this year.

Amalgamating the views of several trusted sources (The Economist, Wall St Journal, several other sources):

- China is counting on rising real estate prices to drive domestic economic demand / expansion. The central government is aware that a real estate asset bubble is growing but is permitting the growth (just like Greenspan did). So far, the bubble is less dangerous because Chinese people must have very large down-payments (30-40% is not uncommon vs we had 0% down-payments here).

- There is a dangerous disconnect between how real estate policy is designed with the central gov’t—and how it is implemented. Local gov’t officials are corrupt and frequently steer money provided from the central gov’t to projects of their friends / people that have paid bribes. This is not an efficient / market driven method of allocating capital. This in turn increases the likelihood of bad debts in banks as well as real estate bubbles.

- Bank lending exploded as a result of their stimulus this year. This money went into real estate lending as well as the purchase of stocks.

- When this information became known (2 -3 months ago), the Chinese equity market sold off. Our protective sell limit order was triggered.

- Since the summer, the Chinese central gov’t has pulled back the reins on bank lending. Chinese markets are recovering and beginning to make new advances with far less central gov’t bank stimulus. A good sign.

- China trades more with its local neighbors than with the USA. China also trades more with Europe than the USA. So if the USA stays in an economic funk, China will be impacted but not as much as it might have as recently as 5 years ago.

- China announced 3Q GDP growth today. 9% annual rate was expected. 8.9% was delivered. Granted this data comes from the Chinese central gov’t so we need to put big error bars on it.

Upshot:

- Plenty of risk is involved in the Chinese market i.e., exposure to 25-30% losses in the short term if either asset bubble bursts. Longer term, the Chinese stock market will likely surpass its previous peak within the next 5 years — this is 2X where it is now – and roughly where we sold our China ETF 2 years ago.

- Because the Chinese market may be 25% lower in 3 weeks time (or not at all) we are wading back in with 3% this week or next and look to buy on dips up to the model proportions (5-6%) by the end of the year.

- Today’s GDP data was not received terribly well. Institutional investors are increasingly looking to be surprised on the upside in order to drive prices higher.