“Time crumbles things; everything grows old under the power of Time and is forgotten through the lapse of Time”
– Aristotle

There is one thing that is consistent about the markets; people forget the pain and agony of past bubbles only to create new bubbles. Does anyone remember the mid-80’s when many people were concerned about Japan taking over the world? Do you remember the Japanese buying Pebble Beach for $1 billion? The Japanese stock market was the envy of the world at that time with the Nikkei rising to over 38,000 – the Nikkei is presently just over 15,500 today! We would contend that China is the next bubble to burst in the near future.

The Japanese market of the late 80’s and the Chinese market of today are eerily similar. First is the “made in” similarity. In the early eighties, it seemed like everything was made in Japan. Today, it seems like everything is made in China. Second is the run-up of the stock market. For the three years ending in 1988, the Japanese stock market cumulatively rose 288%. The Chinese stock market is up 285% since the beginning of 2004. Third, the Japanese government manipulated the yen in order to keep it pegged closely to the US dollar until the late 80’s. In the late 80’s, the yen was allowed to float on its own. China’s currency – the Yuan – is pegged currently to the US dollar. Pegging a currency to the US dollar has historically proven to be helpful for developing countries initially because it helps to stabilize their economies. However, if the peg is kept too long, it can create financial stress on a country’s economy. The Japanese stock market dropped shortly after the government let their currency float. In 1997, many developing countries in Asia followed Thailand’s lead to abandon the US dollar peg. These countries suffered greatly during the Asian stock market meltdown in 1998. China has allowed the Yuan to appreciate 12% against the US dollar since July, 2005. However, with Chinese inflation running at an eleven year high of 6.9% in November, we believe the financial stresses in China will make them abandon the dollar peg in the near future. Doing so will bring down inflation as foreign goods automatically become cheaper. The final issue is cross ownership of stocks by companies. In Japan, many companies own shares of other companies, especially those with whom they do business – this is called “Keiretsu”. In China, not only are companies investing in other companies, but the Chinese government is the largest shareholder in many companies. Earnings of many companies in China are rising because of the stock they own in other companies. For example, Jilin Aodong Medicine Industry Group had earnings of $132 million for the first six months of 2007. Ninety-six percent of those profits came from the increase in stock price of Guangfa Securities Co., which Aodong has a large stake in! This is reminiscent of technology companies owning start-up internet companies in the late 90’s. It is great when the market is rising, but it is devastating when the market starts to turn.

As you know, we are significantly overweighted in US growth stocks at the current time. This has helped you, our client, this year and we believe you will also benefit when China ultimately bursts. Below is a comparison of the Japanese stock market and the Russell 1000 Growth Stock Index for the three – bubble – years ending 1988 and the three years thereafter:

During 1988-1991, value stocks were also positive. However, their return of 43% was less than half that of the Russell 1000 Growth Index.

When comparing the returns of the Chinese stock market over the last 3+ years to US growth stocks – the Russell 1000 Growth Index – the comparison looks eerily similar to the comparison of the Japanese stock market of 1986 – 1988 to the Russell 1000 Growth Index during that same period.

As history has a way of repeating itself, are we in for a strong performance in US growth stocks over the next three years? According to our model, the answer is yes!

The Chinese market also seems to be overpriced. For example, there is a gold mining company in China selling for more than its reserves – in the US, gold companies are selling at 25% of their reserves. As the Great One – Wayne Gretzky – said, “Everyone else skates to where the hockey puck is. I skate to where the hockey puck is going to be”. We at THOR strive to go to where the market returns will be – growth stocks.

Changes at THOR

We are saddened to inform you that PJ will be leaving the THOR family. Her last day will be January 11th. PJ needs only 29 hours to complete her college degree in psychology and sociology. It has been a lifelong goal of hers to get her degree and pursue a career in this field. All of us at THOR wish her the very best in this endeavor. She will be missed, but understand her desire to pursue her lifelong dream. PJ wants us to indicate that she has really enjoyed working with each and every one of you and that she will miss the interaction with everyone. Please wish her well if you see her or speak to her before she leaves.

In her place, we have hired Joan Sigman. Joan has seventeen years of customer service experience, the last seven of which have been with Charles Schwab & Company. Joan’s first day will be January 7th. We are excited to have her and believe she will be a great addition to the THOR team.

Our investment team is also growing. On January 16th, Kevin Mackey will be joining THOR as a research analyst. Kevin is a December graduate of the University of Dayton where he majored in finance and minored in accounting. Kevin is a lifelong resident of Cincinnati and a graduate of Saint Xavier High School. We are excited about Kevin joining the THOR team.