Listen to the smart money

I don't know what came over me yesterday publishing a bullish article on the Chinese stock market so here is a return to form with an article warning of red flags being raised by the 'smart money' in Asia.

Chinese food for thought
Commentary: Pay attention: The smart money in Asia is raising red flags

By Todd Harrison

Last Update: 11:16 PM ET May 22, 2007

"Sun-Tzu: If your enemy is superior, evade him. If angry, irritate him. If equally matched, fight, and if not, split and reevaluate."

Bud Fox, "Wall Street"

NEW YORK (MarketWatch) -- In the sixth century, "The Art of War" laid the groundwork for modern-day military strategy. Ironically, it may also be offering sage advice as we edge through the finest times in Chinese financial history.

In the past week, three prominent Far East figures have voiced concerns over the Shanghai ascent.

Li Ka-shing, the richest man in the region, said, "There's a bubble in the China stock market" and, "The high price to earnings ratio is reason to worry." He also cautioned investors against short-term speculation, saying, "They should have learned a lesson from the Asian financial crisis of 1997."

Merrill Lynch & Co.'s China chairman followed suit a few days later, noting that, "it's getting out of control," and, "investors should pare holdings," citing those very same valuations where prices are, on average, trading at 51 times earnings.

Finally, billionaire Lee Shau-kee, chairman of Henderson Land Development Co., opined that Chinese shares trading on mainland markets are at an "unreasonable'' premium to those in Hong Kong, threatening to create "a bubble.''

Smart money, one and all, offering seasoned Chinese food for thought.

To be sure, holders in the region have plenty to digest on the heels of a rally that has tacked on 54% this year and 248% since the beginning of 2006.

There's nothing wrong with meteoric growth, mind you, particular for those savvy enough to have made that bet a few years ago. China is the motor that powers the world economic engine. It is, in many ways, what the United States used to be. That's a blessing, but it may also portend a curse.

When I heard these comments, my mind meandered to the immortal words of Alan Greenspan, who first whispered "irrational exuberance" in 1996. He was prescient but early, missing the meat of the historic stateside blow-off.

That thought is a valid one, as the last phase of the denial-migration-panic trifecta is always the sharpest leg of any market move.

But perhaps there's serendipity or symmetry in the fact that Greenspan has now entered the private sector, placing his chips alongside Bill Gross at Pimco. It seems that everyone wants a piece of the pie, even if the crust is baked in China.

To wit, we've seen alliances emerge, such as Beijing's investment in Blackstone, that seemingly set the stage for a massive transfer of wealth. After all, if the world reserve currency continues to falter, as the U.S. dollar has to the tune of 30% since 2002, foreign accumulation of stateside assets is a logical and necessary progression.

The trick to this trade, from where I sit, is the way that it's postured to the public and executed in private. With foreign holders controlling the majority of our debt, they are, in theory, calling our fiscal and monetary shots.

Ben Bernanke and Hank Paulson are walking a tightrope, with nationalization on one side and isolationism on the other. A swift breeze from either side will bring imbalances to bear, which is precisely the reason that policy makers from both countries are currently meeting in Washington.

We know there is inflation in things we need to power, educate and feed the world and simultaneous deflation in discretionary items, consumed mostly by the debt-dependent U.S. consumer. The goal is orchestrate a gradual transition that allows for stable and sustainable coexistence.

Globalization isn't evil. Quite the contrary, it has allowed emerging markets to assume a larger role in the supply-demand equilibrium. For every action there is an equal an opposite reaction, however, and the other side of that trade is upon us.

The U.S. is no longer the dog that wags the world's tail. That role has been transferred to China and our collective fortunes rest in the decision making process of a foreign power. Again, there's nothing wrong with this as long as we remain aware and prepare ourselves in kind.

Most Americans are quick to dismiss the new world order for fear of being called unpatriotic. The rub is that the process of financial democratization is the very definition of capitalism, the same brand that we've been espousing and projecting for centuries.

I don't claim to know everything there is to know about China but I do know this. If there's one constant across borders and throughout time, it's the wisdom to pay attention to those in the know.

And when the smartest money in Asia is raising red flags, it behooves us all to respect the risk.

Todd Harrison is the founder and CEO of Minyanville.