The World's No. 1 Economy May Surprise You

The world's No. 1 economy may surprise you... More great news for Sjug's True Wealth China Opportunities subscribers... A 'giant ball of money' could be headed to this market... Bullish or bearish, you must prepare for more volatility... Your chance to try Crypto Capital, absolutely risk-free...

What's the world's largest economy?

If you're like most folks, you probably believe it's the United States. After all, U.S. gross domestic product (or "GDP") is an incredible $18.6 trillion. That's more than 65% bigger than China's... and more than three times the size of those of Japan, Germany, and the U.K.

But according to Stony Brook University finance professor Noah Smith, you're wrong. In reality, China has already surpassed the U.S. We just don't know it yet, because we're looking at the wrong data.

It's a controversial idea for sure. But Smith makes a compelling argument. As he explained in a Bloomberg View column on Wednesday...

This comparison is misleading, because things cost different amounts in different countries. GDP is supposed to measure the amount of real stuff – cars, phones, financial services, back massages, etc. – that a country produces.

If the same phone costs $400 in the U.S. but only $200 in China, China's GDP is getting undercounted by 50% when we measure at market exchange rates. In general, less developed countries have lower prices, which means their GDP gets systematically undercounted.

When you take these price differences into account, the picture looks a little different...

Using a wonky adjustment that economists call purchasing power parity ("PPP"), China's economy swells to more than $21 trillion – nearly $3 trillion bigger than the U.S. More important, Smith argues China's lead is only likely to grow from here...

China's modest per-person income simply means that the country has plenty of room to grow. Whereas developed countries can only get richer by inventing new things or making their economies more efficient, poor countries can cheaply copy foreign technology or imitate foreign organizational practices. That doesn't always happen, of course – many poor countries find themselves trapped by dysfunctional institutions, lack of human capital or other barriers to development.

But there's good reason to think that China will overcome at least some of these obstacles. Economists Randall Morck and Bernard Yeung have a new paper comparing the histories of Japan and South Korea – both of which climbed out of poverty to achieve rich-country status – with the recent rise of China. They find that China's institutions are, broadly speaking, developing along the same path followed by its successful neighbors.

And data continue to suggest this is likely. Despite a slowdown in recent years, China's economy is still growing at a rate of nearly 7%, according to the latest quarterly report this morning – compared with a little more than 2% in the U.S.

At that rate, Smith notes China's economy will be twice the size of the U.S. in less than two decades.

Whether it's the largest or second-largest, China has undeniably become a dominant economy today...

And yet, the Chinese stock market – which is also larger than any other besides the U.S. – remains one of the least owned in the world.

Regular Digest readers know this is one of the biggest reasons our colleague Steve Sjuggerud turned bullish on China – and launched his True Wealth China Opportunities advisory – last summer.

As Steve noted at the time, virtually no one owned local Chinese stocks, known as "A-shares." U.S. investors hated them. They were largely excluded from global stock market indexes, which meant large institutional investors like mutual funds couldn't touch them, even if they wanted to. And even Chinese investors – which had just been burned by a mini-boom and bust in 2015 – had no interest in buying these stocks.

Steve's contrarian call has paid off for his subscribers. But despite the big gains in Chinese stocks over the past year, most investors still don't own any Chinese stocks. However, that may be finally starting to change...

As we've discussed, index provider MSCI finally agreed to begin including Chinese A-shares in its indexes back in June. Starting next year, hundreds of billions of dollars in institutional money will be forced to start buying these stocks. And large private investors and hedge funds have already begun moving in advance.

But the biggest move may come from inside China itself...

A recent note from Morgan Stanley analysts pointed out nearly $2 trillion of Chinese savings could flow back into A-shares over the next few years.

Why? Because Chinese investors increasingly have no other choice.

The Chinese government has been cracking down on speculation in many areas of the market. Equities are now one of the last remaining options. As Bloomberg reported last night (emphasis added)...

Property, overseas investments and shadow-banking products have all been targeted by China's campaign to curb financial risks over the past year. What's left?

Some analysts are betting that restrictions on other popular investment channels will lure what's often called China's giant ball of money back into stocks, which, despite steady gains, have seen a slow take up in volumes since a spectacular boom and bust in 2015.

Chinese equity holdings will swell by up to 11 trillion yuan ($1.7 trillion) in the two and a half years through end-2019 amid policies to clean up the financial system, Morgan Stanley predicts.

More important, improving fundamentals coupled with investors' recent experience in 2015 suggest this move will be more sustainable. As lead analyst Richard Xu explained in the note...

Rebound in corporate profit growth and still-high savings rate will support fund flows to quality equity names. This will be a lasting but somewhat gradual process, unlike the boom in 2015.

In other words, despite the big gains in Chinese stocks this year, all signs suggest the real rally hasn't even started yet.

Of course, regular readers know Steve isn't just bullish on China today...

He also believes we're in the early stages of a "Melt Up" – an explosive final "inning" of the long bull market – here in the U.S.

It's too soon to say if Steve will be correct about the Melt Up... But we certainly wouldn't bet against him. No one has called this bull market better.

But regardless of direction of the market's next big move, one thing is certain: Volatility won't remain this low forever. Most folks would expect volatility to rise if a bear market begins. But as we've discussed, you also need to be prepared for more volatility if the Melt Up continues.

Our colleague Ben Morris agrees...

As he explained to his DailyWealth Trader subscribers on Monday, history suggests the Melt Up will be anything but a smooth "ride" upward...

One of the funny things about bull markets is that they like to take as few people along for the ride as possible. They'll throw you off and trample you, given the chance.

Just look at a chart of the Nasdaq from late 1998 through mid-April 2000. During the final 15 months of the last Melt Up, the Nasdaq soared 146%... But it also dropped 8% or more, six times...

This would be a dramatic change...

We haven't seen even one 10% correction in nearly two years.

This means most folks probably aren't ready for this kind of volatility, mentally or strategically. Regardless of your stance on the Melt Up, if you have any money in stocks today, you need to prepare.

To prepare mentally, Ben suggests printings out the above chart and taping it to your computer monitor as a reminder. But to prepare strategically, he says you need to get comfortable with missing the boat. As he explained...

During a Melt Up, you won't know when a sharp decline is coming. The chart above shows the Nasdaq... which is an average of thousands of stocks. When the index fell 10%, lots of individual stocks fell far more.

If you happened to buy a stock at the wrong time, you could have stopped out for a 15%-25% loss in a matter of days... then watched as it doubled, tripled, or more. You could have missed the boat.

So what does this mean in practice? He says there are two important things to keep in mind...

First, during a Melt Up, you won't know which decline will be the start of a bear market... So you need to set stop losses on all of your positions and stick to them. It's one of the best ways to protect your wealth.

You may miss the biggest gains on some, or even a lot of stocks. But that's OK. As long as you follow this next piece of advice, you should still do extremely well...

You need to be picky about your entry points. If a stock looks great – but has just popped higher – wait for a pullback before you buy. By waiting for a pullback, you'll greatly reduce your chances of stopping out of that stock ahead of the next big move.

If you're picky about your entry points, you'll again miss the boat sometimes. The stocks you want to own won't always pull back to a convenient entry point. But at least this way, if you miss the boat, you won't take a big loss beforehand.

One last note before we sign off today...

As you likely know, we held our first-ever cryptocurrency webinar last night. Porter was joined by our friend and colleague Tama Churchouse – editor for our corporate affiliate, Stansberry Churchouse Research – for an in-depth conversation on bitcoin and other "cryptos." If you joined us, we hope you enjoyed it as much as we did.

But if you couldn't make it, it's not too late to take advantage of a special discount on Tama's exclusive new cryptocurrency advisory, Crypto Capital.

We just had a look at the introductory materials, and we can say without a doubt that it is among the highest-quality cryptocurrency research available anywhere, at any price. It is comprehensive enough for even experienced crypto traders, but clear and simple enough for even a total novice to understand. A subscription to Crypto Capital also includes five step-by-step user guides and nine short video tutorials from Tama himself, walking you through everything you need to know to get started.

If you have any interest in speculating in cryptos, you owe it to yourself to learn more. Tama will even give you a full 30 days to try this service, absolutely risk-free. Click here to learn more.

New 52-week highs (as of 10/18/17): AbbVie (ABBV), Becton Dickinson (BDX), Biogen (BIIB), CBRE Group (CBG), Global X China Financials Fund (CHIX), WisdomTree U.S. SmallCap Dividend Fund (DES), WisdomTree Japan Hedged Equity Fund (DXJ), Eaton Vance Enhanced Equity Income Fund (EOI), iShares China Large-Cap Fund (FXI), Alphabet (GOOGL), Intel (INTC), iShares U.S. Home Construction Fund (ITB), JPMorgan Chase (JPM), McDonald's (MCD), iShares MSCI China Index Fund (MCHI), AllianzGI Equity & Convertible Income Fund (NIE), ProShares Ultra Technology Fund (ROM), ProShares Ultra Health Care Fund (RXL), ProShares Ultra S&P 500 Fund (SSO), Tencent (TCEHY), ProShares Ultra FTSE China 50 Fund (XPP), and Direxion Daily FTSE China Bull 3X Fund (YINN).

Did you join us for last night's cryptocurrency event? Were you convinced to speculate on this explosive asset class... Or do you still think they're far too risky? We'd love to hear from you. Let us know where you stand at feedback@stansberryresearch.com.

Regards,

Justin Brill
Baltimore, Maryland
October 19, 2017