At first glance it may seem gratuitous to discuss China and other autocratically-run emerging markets with a headline drawn from a movie which had nothing to do with China, and almost nothing to do with LA’s Chinatown. But in fact the character of the film Chinatown’s villain, Noah Cross, is loosely based upon the real-world first superintendent of the Los Angeles Water Department, William Mulholland.

Mulholland is alleged to have lied to, cheated and threatened the farmers and ranchers of the Owens Valley, which was then called “the Switzerland of California,” thanks to the abundant snow runoff from the Eastern Sierra. He promised that only a small amount of their water would be diverted via a grand project that became the Los Angeles Aqueduct. In fact these residents were merely pawns in the game to turn the near-deserts of the San Fernando Valley into an oasis of agriculture and commerce. All their water was taken from them, resulting in the dry lake bed that has replaced Lake Owens and the desert that replaced grazing and farming lands, both results on display today as one drives from LA to Reno along Highway 395.

As these rural residents lost not only their livelihood but came close to losing their means of survival, Mulholland’s provocations became more intense. The result was the biggest of the California Water Wars, with the aqueduct being dynamited in various places. When the press and the state politicians refused to sanction any more abuse of these citizens, Mulholland was quoted as saying that he "half-regretted the demise of so many of the valley’s orchard trees, because now there were no longer enough trees to hang all the troublemakers who live there."

Mr. Mulholland met his own Water-loo just a few short years later when a huge dam, which he had personally inspected and declared safe only 12 hours prior, burst and collapsed, spilling a torrential river 140 feet high into the valleys below. In addition to the untold physical destruction, more than 600 people were known dead, including over 100 children, most buried in mud or swept into the ocean.

What does this have to do with China today? Noah Cross was an autocrat, a sociopath and a narcissist. Autocrats, sociopaths and narcissists make lousy investment partners. We don’t invest in China, we don’t recommend investing in China, and we do our best to dissuade our friends and clients to avoid such investments as long as China is run by the Communist Party of China or any other set of centrally-controlled statist autocrats. 

We avoid China because of the chicanery, subterfuge, opacity, venality and conniving of those who are party members, particularly its elites. Their arrogance and contempt for the “stupid villagers” in the rural areas out in the hinterlands evokes the fictional Noah Cross and the not so fictional William Mulholland. Their desire for personal reward and their sense that all benefits must flow to Beijing is little different than that of the water architects of Los Angeles. 

And their propensity for gargantuan state-sanctioned projects to “transform” their nation in a giant leap forward, no matter who gets in the way, is redolent of the film’s characters, only on a much larger stage with considerably more disastrous consequences. In just one such project alone, the building of the Three Gorges Dam, 13 cities, 140 towns and more than 1600 villages were submerged, forcing the relocation/dislocation of more than 1.3 million people. Landslides, faulty construction forcing regular patching, and ecological deterioration followed in its wake.

And now the first phase of the South-to-North dams/pumping stations /canals project has been completed. It is even larger. When finished it will force flowing water over five major identified fault lines, including the epicenter area of the one where an earthquake killed 70,000 people in 2008. Inevitably with such grand schemes involving more than $55 billion, some of those funds will find their way via graft, corruption, skimming and thievery into the hands of those arrogant enough and powerful enough to take what they consider to be their share. What does the film Chinatown have to do with China today? A lot.

Emerging Economies / Frontier Economies

Given that emerging markets have dropped some 28% in the past year, many investors are ready to begin buying. At single digit PEs after such a decline, a lot of folks find the valuations compelling. We are not among them. Some emerging markets are transparent, like India. (India is a cacophony of dissonance and a jumble of regulatory and cultural hurdles but at least it is transparent!) Most, however, are more like China and Russia, where the average citizen is denied opportunity, almost all decisions are made by a few at the top willing to toe the party line, and where the only numbers you can trust come from your own analysts. Whatever the government claims is said for political expediency, not for economic truth-telling. 

We avoid even more scrupulously the “frontier” markets and for much the same reason. Myanmar, Vietnam, Guatemala, Mongolia et al are enticing for some; it’s cool to imagine being the first to invest in such places with dreams of untold wealth as others follow the path they have marked. I have three words for such dreamers: Don’t Do It. 

Take Myanmar, which I will refer to as Burma since that is more inclusive of the 135 distinct ethnic groups in Burma than the Burman (Burmese) word Myanmar. I was an air attaché there in the 1990s and have followed the careers of some of the majors and lieutenant colonels I knew then who later rose through cunning, guile and brutality to be the leadership elite of the country. It did not particular surprise me when, in 2005, these paranoid autocrats decided, with no warning, to occupy a new capital 200 miles north of Yangon (Rangoon) and force the civil servants that keep the country running, to the extent that it does, to follow them within 48 hours. For all I know, then-strongman Than Shwe, always a sucker for a good astrological forecast, decided to heed one of his soothsayers.

The point is, when you invest somewhere with a capricious-at-best rule of law, with limited or no transparency and a completely different set of cultural biases, interpretations of morality and mortality, and ethics, you deserve what you get. Avoid.

So Much For What to Avoid. Now — What Are We Buying?

Since my last article, we have re-purchased CHAD and SDS and added new purchases of ProShares Ultrashort Russell 2000 (TWM,) AdvisorShares Ranger Equity Bear (HDGE) and ProShares Ultrashort QQQ (QID.)

For clients with a more conservative portfolio, rather than hedging to make a profit on any decline, we are trying to buy great preferreds that tend to move only a few pennies a day no matter how volatile the markets.. The problem is that many of these are really lightly traded so a bid-ask of 24.45 / 24.65 is not unusual. Even if we were to pay the asking price, the moment the first couple hundred shares execute, the ask moves up to 24.75 or 24.80. We are patient investors, however; we’ll get more of these over the coming weeks. Among those we’re actively trying to gain positions in are Cullen Frost pfd A, HSFC (HSBC Finance) pfd B, Alcoa pfd B, EPR Properties pfd C and, as a speculation on a rebound, but a speculation (!) Intelsat pfd A. (And of course all our different PSA series preferreds that we’ve discussed previously, as well.)

Finally, for the third leg of our triad, we have entered some opportunistic, well below the current price, orders on crème de la crème companies. I don’t “expect” another 1000-point flash crash that then recovers but if it happens I won’t mind profiting from it by initiating positions in superb companies at great prices and holding them for the future. Among these are some names well-known to all investors, like Apple (AAPL), Disney, Exxon Mobil (XOM), and Chevron (CVX). To this short list I’ll add Gilead (GILD), Spectra Energy (SE), and Caterpillar (CAT). If we get them, it’s a gift in the middle of what would otherwise be a catastrophe. If we don’t, we may still buy them there after a steady drip, drip, drip decline. As always, do your own due diligence!