On April 12, 1996, I stood behind one of the head institutional traders at Merrill Lynch Canada and watched Yahoo Inc. stock triple in value in its first hour as a publicly traded company. It was pure speculative mania ungrounded in anything resembling fundamental value. We knew it couldn't last, but for three years it did; indeed the Nasdaq stock index itself would rise another 600 per cent.
China's real estate and infrastructure boom is showing all the same characteristics as the tech bubble, for similar reasons, and although three more years of speculative fervour is not guaranteed, at some point the end game is likely to resemble late 1999. The final implosion of China's growth miracle will put the final dagger in the resource supercycle that has enriched so many Canadian investors.
One of the central preconditions of a major asset bubble is a funnelling of investment into one specific asset class. In the late 1990s, the tech bubble soaked up the preponderance of new global investment dollars. Between September, 1995, and March, 2000, the tech-heavy Nasdaq outperformed the equal-weighted S&P 500 index by an enormous margin – 659 per cent to 81.5 per cent.
In China, in part due to an illiquid, underperforming equity market, investment assets in the world's second-largest economy are increasingly concentrated in real estate. Forbes magazine recently reported a $2.3-trillion (U.S.) year-over-year increase in Chinese mortgage debt equivalent to almost 25 per cent of GDP.
The end result for both the tech bubble and in China is excess in terms of asset prices. Cisco Systems traded at more than 220 times trailing earnings by March, 2000. In China, year-over-year housing prices are climbing at a 15- to 20-per-cent clip in most regions and they are now the most expensive in the world as a multiple of median wages.
The Atlantic notes how ridiculous things have become: "[T]he mid-range price of an apartment in New York is 6.2 times more than what a typical family makes in a year. By comparison, it would take nearly a quarter-century of earnings to buy a pad in Beijing's capital outright."
There are numerous cracks appearing in the China growth story, and just like the late 1990s, market commentators are arguing "it's different this time," that the $3.1-trillion in dodgy local government debt doesn't matter, that it's okay to construct apartment buildings that will remain empty because only speculators can afford them.
The investor lesson from the tech bubble is that the trees do not grow to the sky. Investment trends – particularly those that start as legitimate and powerful – eventually succumb to overinvestment and excessive prices.
The process is the same each time. Capital flows in faster than it can be profitably utilized. Powerful interests – investment bankers in the 1990s, real estate developers and prominent public officials in the current China – are eventually forced into complex financial plate-spinning to try and maintain momentum.
Economic and financial revolutions all go like this and they all end badly. The internal combustion engine – the tech revolution of the 19th century – created the British railway bubble and another in the U.S. auto industry in the 1920s. More recently, mortgage securitization resulted in the U.S. housing bubble.
China's economic revolution will likely go the same way, although hopefully less dramatically. It won't be the end of the world. Much in the same way that the vast majority of British railways were built after the investment bubble collapsed, the eventual burning off of bad debt and economic restructuring (toward household consumption) will put China on a sustainable, investable growth path.
Predicting the exact timing of a market top is a mug's game even in cases such as China, where all of the signs of credit stress are already clear. The trick for Canadian investors will be getting out of the way, minimizing resource exposure, before China's economy reaches its version of March, 2000.