The US wins the race back to the top

As I write this morning, the Dow Jones Average sits at a new all-time high, which makes this both an historic day and a depressing one, depressing because it means zero capital gain from stocks for five and a half years.

In Oz it's even more depressing. The Australian All Ordinaries is still down 26 per cent from its 2007 high; the 20 leaders, our closest equivalent to the 30-stock Dow, is 16 per cent below its peak; and the All Ords accumulation index, including dividends, is 6 per cent below it. The 20 leaders accumulation has delivered a positive return of 8 per cent over 5.5 years, or 1.4 per cent a year.

Meanwhile the Shanghai Composite Index is still a dismal 60 per cent below its 2007 peak.

And the assets to have been in? Gold and bonds. Gold, which pays no interest or dividend, has produced a compound annual return of 14 per cent over five and half years, and US high-grade bonds have delivered an annual total return of 7.6 per cent. Junk bonds have delivered 9.5 per cent a year, compound.

What does all this mean? Well, of course it's a picture of a bear market. Take your pick whether it's a 13-year secular bear, starting with the S&P 500's peak of 1552.9 on March 24, 2000 (it's currently 1541 by the way), or a five and a half year cyclical bear starting with the 2007 peak of 1550 (October 17).

Safe assets – gold and bonds – have been in a bull market, naturally, and in fact bonds are arguably the new bubble, heading for another 1994-style crash. Gold has been rising against all paper money, as the supply of the latter blows out.

In anticipation of a bond crash, safe haven money has been moving from fixed interest securities to high yielding equities for more than nine months. The Australian bank accumulation index (capital plus dividends) is up 49 per cent since June 4 – an annualised return of 70 per cent. Over that period, gold and bonds have delivered zero returns.

But the really interesting story is America and China.

Chinese stocks have been a disaster zone… in fact the Shanghai Composite collapse is worse than the great Nikkei crash of 1989-90.

In the two years leading up to the Japanese bust, the Nikkei tripled before crashing 60 per cent; in the same period leading up to the China index's peak in 2007 it quadrupled and then fell 70 per cent.

Until the yen started tumbling three months ago, the Nikkei was wallowing with the Shanghai at less than half its 2007 peak but has since rallied 40 per cent on the back of a 15 per cent currency depreciation.

But the Dow is back at its peak, and flying. The market is saying the US economy is headed for a breakout year in 2013, while the Chinese economy is struggling.

Of course, the Chinese GDP growth rate is three times that of the US, but everything is relative.

It's partly about debt. While China remains mired in debt thanks to a real estate bubble and infrastructure loans being forced on local governments, the United States has deleveraged, sector by sector: big companies and banks first, then households, small business, state and local governments, and now the federal government has started (albeit kicking and screaming).

In his 'Government Work Report' yesterday, outgoing Chinese Premier Wen Jiabao said that the targeted growth rate of 7.5 per cent for this year would be challenging. Also he headed the section on 2013 tasks as "Suggestions” rather than the usual "Objectives”.

And China's National Development and Reform Commission has reportedly warned of "acute risks” in the country's development model, with the government running big deficits to support infrastructure spending.

In other words, "socialism with Chinese characteristics”, as Deng Xiaoping described it, is running out of steam and may be headed for crisis.

Meanwhile what might be called "capitalism with American characteristics” is being reborn after a near-death experience in 2007-08.

America's is NOT laissez-faire capitalism. The bank bailouts of 2008 and the 'quantitative easing' by the Federal Reserve since 2010 represent as much central planning as the enforced fixed asset investment that has been propping up China's economic growth for five years.

The difference is economic freedom and innovation. In the past five years, for example, Apple has released a succession of high-margin iPhones and iPads and became the world's most valuable company. Chinese firms made them, on low margins.

Now the US has the tailwind of cheap domestic energy as well. China, unluckily, has to ship its energy in.

As it often does, the stock market is telling the truth: America and China are both in woeful shape. It's just that America is the least woeful.


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