Yardeni On China's Stock Bubble Bursting & Rethinking US Stocks

July 13, 2015

Ed Yardeni is president and founder of Yardeni Research, a global investment research strategy firm. A former economist for the Federal Reserve Bank of New York, he is widely followed by institutional investors for his investment strategy publications. Dr. Yardeni is often seen on CNBC and is published in financial publications like the Wall Street Journal, The New York Times and Barron's.

ETF.com: What's happening with China's stock market? Of course, we've seen a pretty long rally, so a correction isn't completely out of the ordinary. But it does seem like something is out of the ordinary here.
Ed Yardeni: China seems to have inflated a stock market bubble in record time. The People's Bank of China started to lower interest rates again in November and that seemed to have fired up the speculative mood in China. Many Chinese have a very high savings rate. And so they need to put it somewhere.

For the past several years, Chinese investors have been putting their money into property, into real estate, buying second, third apartments that have been sitting vacant in these so-called ghost cities. But the government tried to discourage that kind of speculation, and raised the down-payment requirements. And so Chinese investors, with all this cash around, have been pouring into the stock market.

They created a huge bubble in record time that's bursting. I don't think this is a correction; I think this is a bursting of a speculative bubble. And the fact that the government is resorting to all these desperate measures—suspending trading and prohibiting selling—just worsens the prospects for the stock market. Who's going to want to buy into a market where the government can mandate that you can't sell your position?

This is going beyond the stock market and creating a real credibility problem for the government. For many years, everyone's had confidence that the government could manage the economy and could provide the kind of programs necessary to keep the economy growing. But they're really blowing their credibility big time here with this effort to prop up the stock market in an economy that's clearly slowing and has lots of problems, particularly excess capacity, deflation and too much pollution and corruption.

ETF.com: Is this something that could reverberate to American investor?
Yardeni: The most immediate investment implication is that China's growth will continue to weaken, which is already putting more downward pressure on commodity prices. I would certainly not want to be long any commodity-related securities, whether it be gold, gold miners or copper shares.

It's been interesting to note that gold hasn't rallied on all the commotion in Europe and in China. And that's because gold tends to follow the trend of industrial commodity prices, and they're falling.

On the other hand, the U.S. economy is looking more and more resilient. It's likely to weather the overseas storm in Europe and in Asia. We have a very resilient, diversified economy. The U.S. consumer is in relatively good shape. Housing activity is picking up. It may very well be time to switch back from the "Go Global" investment strategy with a capital G on both of them, to a "Stay Home" investment strategy, with a capital S, capital H.

Throughout this bull market, I've been promoting a "Stay Home" investment strategy, but I wavered in the beginning of the year, conceding that we couldn have some outperformance overseas, because the U.S. is relatively overvalued relative to Europe and some other markets. But I think the fundamentals now point back to the U.S.

And all this commotion increases the odds of only one rate hike over the remainder of the year, one-and-done. But none-and-done also looks increasingly likely.

ETF.com: And do you think a rate hike is built into that yet?
Yardeni: I think so, especially if the perception is it'll be one-and-done. The Fed will raise rates not because it really wants to raise rates, but it just wants to demonstrate it can do it. It needs to do it for its credibility's sake. And then it'll just hold off for another six to 12 months before it does anything again.

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