Wednesday, September 26, 2007


Sometime a month ago, my mentor wrote in his column about the impending burst of China’s asset bubble. At first glance, one would think that such an article are but one of the many China bashing articles that is popping out lately in the press but on a closer reading, one would find out that his analysis (which he got from a broker friend of his) are quite true and right on the bull’s eye. His foremost thesis is that China’s stock prices, which is a proxy for the general asset prices in China is defying gravity. Whereas the global stock market is reeling from the unraveling of the US subprime debt market, China’s stock prices continue to grow to unprecedented heights. And what make this explosive growth trend quite worrisome is that the assets are very much overvalued with some stocks commanding prices of 20 – 50 times their projected 2007 earnings compared to the typical price – earning ratio of a stock is around 12 – 15 times their projected income for the year. An inflated PE ratio signifies that intense speculations are in the works. Of course, speculations are part and parcel of any trading activities and one cannot really remove it totally. Speculation exists because there is an expectation of getting a better price from one’s asset holdings vis – a – vis from the current bid price. Therefore, because of this expectation, people hold onto their assets until the current bid prices raises to match their price expectation. Speculation becomes detrimental only when the asset owner’s price expectation becomes unreasonably high to such an extent that current market demand cannot further digest such exorbitant price. Put it in another way, if a significant percentage let us say 30 – 50% of the asset price is based on pure speculation as in there is no underlying fundamentals to back the price (the value or the worth of an asset doesn’t justify the price), then the price becomes highly unstable for it could collapse anytime at the slightest provocation just like soap bubble that continues to rise but is easily burst at the slightest touch. Prices would finally fall when the asset owners perceived that their price expectations can no longer be realize because the expected demand for their assets do not exists due to that the assets become too expensive already and they began to sell their assets, “trying to cash in” while the prices are still high. Now, if they are only seller in the market and everybody else is either buying or even waiting, it’s not a problem. However, it becomes a problem or more appropriately a crisis when everybody else began to sell and this would degenerate into a panic – selling. Now if just everybody else in the market is selling without regards to their profit or loss and nobody is buying, then we have a stampede and prices will collapse way below their fair market value. And it is this scenario which we refer to as “the bursting of the asset bubble”. Going back to the present day China, signs of an asset bubble are getting obvious. Aside from the inflated stock prices, one can also see the numerous glittering sky scrapers, the new and trendy apartment buildings in the major city centers that remained empty and unoccupied up to now. That’s not all, the explosion of new factories and new manufacturing facilities all over the country added productive capacities in their respective industries in large increments. And these newfound capacities are not backed by real demand but fuelled by easy credit and the perception that good times would last forever. However, technically speaking though, these “over investments” in assets though pointing to a possible formation of an asset bubble wouldn’t be really be considered threatening or problematic as long as the underlying “value” of the assets “could still justify” the hefty price tag. There are signs however in China that shows that asset prices are getting unstable i.e., it might collapse anytime. In Chinese cities, urban dwellers are beginning to complain loudly about stratospheric housing prices prompting government intervention. Furthermore, rate of return on investments of most Chinese companies are falling and some steeply in the last year or so. This is because of chronic over – capacities due to over investments in factories. Companies facing high fixed costs due to amortization needs would most likely shade the prices of their products just in order to incur sales and hopefully break – even. This would in turn lead to a vicious cycle of price undercutting among competition which in turn reduces profitability, and eventually, lowers the rate of return in investments. Due to this development, the Chinese government has now implementing curbs on borrowing to certain sectors of the economy as well as raising interest rates on loans. Higher interest rates tend to deter potential investments especially when the expected return of such investment cannot cover the cost of borrowing to finance the investment. Beijing is hoping that the series of economic measures would be sufficient to “neutralize” the potential threats to the continuous economic growth. In addition to that, recent developments are also threatening asset price stability in China. One such development is in the export front which up to now is China’s main engine of growth. The product quality scare though has negligible effect on the long run is likely to cause a dent in China’s sterling export in the short term. The numerous limits imposed on Chinese exports by EU and other countries. Couple this with the slowing of the US economy due to the credit crisis, China’s export would likely suffer and this would only aggravate the over capacities experienced in many industries in China. Aside from that, government investments in fixed assets such as roads, harbor, ports, airports, etc. are likely to slow down as well given the completion of the construction for the Beijing Olympic Games which is one of the largest public investments made by the government. Without government money to fuel domestic demand, there will be no alternative way out for companies facing challenges on the export front. Hence, the likelihood of an asset bubble and it’s possible bursting especially in 2008 right after the Beijing Olympics according to my mentor. Probably, this is because the Chinese government would do everything it could to present “a prosperous image to the outside world” during the Games and an economic meltdown isn’t exactly showing “a prosperous image” but the story would be different after the Games. Whether or not the economic meltdown would occur as perceived, the real question that one has to answer is what would happen next if China collapses? Well, going back to history particularly to China during the 80s and early 90s, in which China received a trade embargo after the Tienanmen Crackdown. At that time, the economy is experiencing double digit inflations. Bankruptcies was also rampant as some financially weak companies facing a crunch on their cash flow due to lower ROE fails to pay back their loans. This in turn led to the banking system saddling on a huge bad loans. A particular problem that crop up during the 1980 – 1990 economic slowdown was the Triangular Debt Problem. The triangular debt problem came to fore because the State Owned Enterprises (SOE) couldn’t pay back their loans extended to them by State Owned Financial Institutions, which in turn sourced their funds from government particularly local governments. The governments in turn owed the SOE in the form of advances from capital investments in order to fund other fixed asset investments. The result is a huge financial mess. What China did back then to solve the problem was to separate the government from businesses by handing the management of SOE and SOFI over to professional managers instead to government cadres. The government also furthermore liberalizes the economy, privatizing many SOE and allowing foreign investors into China as well as encouraging local entrepreneurs to invest. Lastly, the Chinese government also tweaks the export taxation system and devalues the Yuan. This led to the revival of the economy, which sees it expanding till now. Of course, the side effect of these series of Chinese actions was to indirectly trigger the 1997 financial crisis (though most of fault lies with the various ASEAN economies, i.e., economic mismanagement). Given that, what would one expect that if China’s bubble did get burst in the near term? Well, first of all, one have to remember that China though a market economy isn’t rule by Market Forces alone, i.e., Supply and Demand. China’s economy is very much influenced by the market forces as well as simple administrative fiat of the government. And in the imperative of protecting China’s ruling party’s interest, China wouldn’t hesitate to do whatever necessary to return the economy to growth in order to forestall unrest. And one of the most probable measures is to devalue the Yuan in order to boost exports. Second, with the devaluation of Chinese assets and the massive bankruptcy that could happen, it is also probable that China would further liberalize their economy and allow more foreign participation. As of now, China is gradually tightening it’s control over the economy by putting in place foreign investment restrictions. And these restrictions would likely be relaxed when the time comes. Furthermore, government takeovers of private enterprises particularly strategic bankrupt enterprises are also highly probable given it’s nature for administrative fiat. So as a business people, what are to expect in case of such scenarios? Well, first, expect fierce price competition from China not only due to the devalued Yuan but also to their penchant for price competition resulting from excess capacities. Second, with the Yuan devaluating, it might trigger a round of competitive currency devaluation especially with economies whose exports are in direct competition with China. As such, inflationary pressures would be pretty strong in these economies especially if they are import reliant. Thirdly, for those exporting to China, a Yuan devaluation would make their exports expensive and hence, this would stifle their export growth. On the positive side, a bubble burst of the Chinese assets has its benefits. One of the benefits is the cooling of commodity prices like metals and oil. Commodity prices are breaking record highs lately due in part to China’s surging demand. With the China factor curbed, it is only logical for commodity prices to “fall back to earth”. Another benefit is that for importers of Chinese products either for retail or for use in manufacture, abundant supply and lower Yuan means cheaper price and hence, lower input costs, which could potentially translates to better profit or larger market share in their respective markets for these importers. Still another benefit is that with high bankruptcy rates and a more liberal economy, a fire sale of repossessed assets at rock bottom prices can be expected and this would provide investors who are left out in the current China boom a chance to gain a foothold in China. All in all, whatever happened to China in the coming years, as business people, we are intricately connected to China.

Sunday, September 02, 2007


I discovered a few good books during my recent visit to National Bookstore. In particular, 4 new titles caught my attention and these are: The Set – Up to Fail Syndrome by Manzoni and Barsoux; Marketing to Women, How to Increase Your Share of the World’s Largest Market by Warti Barletta; The Edge of Evolution, The search for the Limits of Darwinism by Michael Behe; and lastly, The Woman’s Advantage, 20 Women Entrepreneurs Show What It Takes to Grow Your Business by Mary Cantado. The first book, The Set – Up to Fail Syndrome talks about the findings of Drs. Manzoni and Barsoux, both are psychologists studying boss – employee relationships. In particular, both discovered a curious phenomenon, the Set – Up to Fail Syndrome wherein almost always the performance of under – performing employees (“laggards”) never seemed to improve but in fact deteriorated even further when their bosses intervene in their activities just to “help” them out. It is a puzzling find albeit one that holds great importance for people in leadership position be it the CEO, the floor supervisor, or even the team leader. It is puzzling since one would naturally expect that with intervention from “higher ups” in a under – performing employee’s activities, these under – performing employees would easily make the grade but the truth of the matter is, not only these under – performing employees fail to make the grade, their performance went from bad to worse. According to the authors, the culprit is pressure. Under – performing employees are under great deal of pressure to succeed and the constant “look over the shoulder” type of supervision puts an even greater pressure on them. As such, they are prone to commit even more mistakes. Furthermore, the close supervision and constant scrutiny will likely uncover more mistakes, mistakes that are previously glossed over. The solution according to the authors is to back off from “helping” these under – performing employees and instead, motivate them and coach them. In short, don’t micro – manage, maintain distance, keep your trust on them, give them a chance to redeem themselves, and let them do what they do best. It is a hard thing to do especially when you have your own performance to take care of but this is according to them, the best way to do it. The second book, “Marketing to Women” is a fairly obvious book. I mean it is general knowledge that women and shopping are inseparable and hence, it is only logical for someone to think of ways to “convince” women to shop even more (as if women need convincing)! My only reaction to the book is that what took Barletta this long to come up a book like that. It should have come out years ago. Well, better late than never. The third book, The Edge of Evolution is a very provocative book. Here the author, Michael Behe explores the common misconception about Darwinian evolution through scientific research and experimentation. His thesis is that evolution do exists but it is not as random or chaotic as what is first perceived by Darwin. In fact, according to him, evolution followed a “logical” path, which signifies intelligent design. In other words, he “seemed” to suggest that there is an intelligent being behind all the grand design in this universe but instead of popping out of nowhere, all things evolved according to a master plan. Haven’t read it though but it do make me wonder, why evolution and not straight forward creation if his thesis would so suggest? Anyway, the last book that I saw is “The Advantage of Women”, which is probably a collected anecdotes of successful women entrepreneurs on their “their secret of success”. Not that I have anything against the concept of women entrepreneurs as my mom being one of them but I am just wondering what “advantages” does a woman entrepreneur have over their male counterparts? Female intuition? I guess not. I haven’t read the book yet and I might not but I do have a few ideas about women entrepreneurs based on experience with my mom and a few customers (who happened to be women entrepreneurs) I’m dealing with. Based on my observation on Filipino businesses (and a few Filipino – Chinese businesses), women are natural accountants regardless whether they took up accounting courses or not. Probably, this has to do with a woman’s training to become a homemaker during their youth. Most of the time, I encounter women purchasing my products. By purchasing, I meant that they look for the product they need, they canvass the price and later on, negotiate the price, haggle for terms and services (alternatively speaking, this may have to do with a woman’s inborn affinity with shopping). Furthermore, in most husband and wife team engaging in business, it is the woman who handles the funds, i.e., the payment of dues, the disbursement of petty cash, the receipt of incomes, and the control of expenditures. Except for Ilocanos, I always collect the dues from the wife, rarely from the husband. I contact the husbands for purchase orders. I deal with the husbands and I shook their hands but at the end of the day, I face their wife and receive from their wife’s hand the payment for their purchases. Always, in a husband and wife business team set – up, it is the wife who handles purchasing (the canvassing and price negotiating aspect), accounting and finance. The husband on the other hand does the dirty work of the actual operations (manufacturing etc) and logistics, which generally refers to the pick of raw materials from suppliers and the delivery of finish products to the customers. The HR or human resources development and marketing functions can either be handled by the husband or the wife but generally, in my experience, if the wife is the “dominant” partner in the business tag team; both functions (HR and marketing) are also performed by the wife. For Ilocanos, the wife’s role in business is usually limited to operations. So what’s the advantage of a woman entrepreneur? Well, I guess for Filipino family businesses, it is the ability of the woman to control and regulate the cash flows of the business. Cash is the life blood of any business. I mean it doesn’t matter if the business is earning tremendous profit or actually making a killing in sales but if it runs out of cash, it is going to shut its door tight because it can’t pay its bills and most importantly, its people. I’ve seen companies (clients of mine) with tremendous potential went belly up because they mismanage their cash flow. And this is where women entrepreneurs spell the difference. This is the “advantage” of women entrepreneurs, Filipino women entrepreneurs.
I also happen to come across a nice business quote of wisdom if I may say. I got this from the book, “The Three Tensions” by Dodd and Favaro. This is actually a business book on finding a “solution” to the age old business problem of balancing sales revenue and profitability, of balancing short term success and long term viability, and of balancing investment and financial health. The quote goes like this; one day, a divisional manager approaches his CEO and complains about the tasks put forth on him that of growing the revenues through increase in sales and at the same time, maintain a certain margin. The divisional manager complains that if he wants to attain a certain revenue growth objective, he had to somewhat cut down the price in order to generate demand but in doing so, he inevitably won’t attain his profit goals. The divisional manager is in a bind on what to do. The CEO then told him the story of a mud hut. In olden times when there is still no electricity, the only way for the people living inside the mud hut to see what they’re doing is to punch a hole in the walls of the hut. To maximize daylight, more holes are needed but the problem is, air; cold air invariably got into the room full of holes. Logic dictates that in order to maintain the warmth inside the hut, there should be no holes on the wall but that would deprive the occupants of the light. So what’s the best solution? According to the CEO, it is not determining the number of holes in the wall needed to maintain just enough warmth in the hut as well as provide the minimum amount of light needed but to discover glass that could allow light to pass through and at the same time shut out the cold air. The moral of the story, never waste your time trying to decide the trade – offs needed to satisfy multiple objectives. Instead, focus your effort in thinking out of the box for a genuine solution to the problem – inventing the glass.